INTRODUCTION1. Historical Background:

a. LABOR + CAPITAL = WEALTH: All societies agree– communism (eliminates capital and emphasizes labor); capitalism (emphasizes capital); socialism (direct labor and capital to most efficient outcome)

i. Capital: funds a business to operateb. Civil War – 1st Public Issuance of Securities

i. Salomon Chase, Treas. Sec. of Lincoln, had idea to finance war by asking citizens for $ via sell of T-bills.

ii. North repaid bonds in early 1900’s; but confederate bonds were never repaid, plunging South into a 100 yr depression b/c they had tied all their capital up into that failed venture.

c. Industrial revolution – huge amounts of capital were needed to finance infrastructure projects, causing the gov’t again to sell T-Bills to the people to raise money.- highly unregulated

d. Great Depression – prior to this time, in the 1920’s, securities industry was not federally regulated (only by states via Blue Sky Laws).

i. FDR took office in 1932 and promised to reform industry, presenting ’33 Act & ’34 Act. Purpose was to boost investor confidence so as to stimulate investing and inject capital into society.

ii. Purpose of securities acts: reaction to abuse- fix problems and level the playing field2. 5 Main Securities Laws

a. Securities Act of 1933 – consumer protection statute, arose from ’29 crash – PURPOSE is to mandate disclosure (via registration or exemptions) so investors can make smart informed, full, fair, decisions.

i. Deals with selling & issuance of securities to the public (raising of capital).ii. Disclosure to the SEC is forced – if insufficient, serves as basis for damages under CL fraud.

iii. Regulates primary and secondary offerings – NOT secondary trading/transactions (that’s ’34 Act).b. Securities Exchange Act of 1934 – regulatory statute, covering exchanges, broker/dealers, public co.,

insiders, tender offers, and provides anti-fraud provisions.i. Created the SEC – increased investor confidence; regulates broker/dealer conduct & how market

runs. ii. Regulates secondary transactions/trading (after market trading)

c. Investment Company Act of 1940 – targets pre-crash abuses of investment pools, regulates investment companies (aka: mutual funds, pool investing).

d. Investment Advisors Act of 1940 – regulates anyone who, for value, gives investment advice in the purchase & sale of securities; regulatory & notably prohibits contingent fees based on performance.

e. Blue Sky Laws (vary by state) only review offering & standard of review is fair/just & equitable.3. Terminology

a. Types of Banksi. Merchant Bank – classical model of getting capital – an institution invests its own money in your firm

to develop your product [put your money up]- like private equity fund- pure capitalismii. Commercial Bank – institution takes deposits & uses it to make investments (i.e.: loans) (e.g.: Citi).

iii. Investment Bank – institution that goes out & finds the money to invest in firm (puts 2 people together).

b. Broker & Dealeri. Broker (NYSE) – exchange market – broker puts B/S together to complete transaction.

1. B has privity to K w/S, but it’s privity w/an anonymous person. B/S each call brokers to make a transaction, brokers then met on exchange floor to complete transaction w/trade going on ticker.

2. Broker gets a commission for this – need be licensed to get commission.3. NYSE – quotes 1 price: last trade price (e.g: $## is last trade b/w B/S that was made through

broker)ii. Dealer (NASDAQ) – OTC market – Dealer sells out of its inventory (B has privity of K w/dealer)

1. Dealer buys a stock from S for their inventory and puts it on the shelf. If someone else wants to buy that stock, dealer takes it off the shelf and sells it to them NO direct privity b/w B/S.

2. NASDAQ – 2 prices listed: 1) bid price (what dealer’s willing to pay), and 2) ask price (what dealer is willing to sell) “spread” is difference b/w bid & ask prices.

iii. Broker-Dealer – someone involved in both the exchange and OTC markets.

c. Debt (3 forms) – you owe someone money: interest rate paid periodically & maturity date to pay it backi. Notes – short term maturity (I owe you); promise/obligation to pay (few days-4 years).

ii. Debentures – intermediate term maturity (5-8 years) (unsecured).iii. Bonds – long term maturity – (10-30 years; secured by assets).

d. Equity – ownership interest in a company (if stock, must do economic reality test to see if security).e. Securitization – taking something not a security and turn it into a securityf. Registration of securities – you register an offering, NOT a security or a company.g. Initial capital – raising money through primary offerings (secondary trading on exchange does NOT go to

company, just changes hands b/w investors).

WHAT IS A SECURITY?1. If it is a security then ’33 & ’34 Acts apply no offer or sell is valid unless registration or exemption2. Statutory Definition of Security:

a. ’33 § 2(a)(1): “security” means any note, stock, treasury stock, debenture, bond...and investment contracti. NO distinction between public & closed corps for ’33 security definition

ii. S 14 of ’33 Act: It is illegal to opt-out or waive SEC laws if it is a security3. Investment Contract: HOWEY TEST

a. Investment contract: default/catchall definition of security- if financial instrument or stock, do Howeyb. SEC v. Howey: D sold rows of orange trees but did not register them as securities. D divided the land and

entered into service contracts saying D would manage the plots and sell the oranges. All oranges would be pooled and marketed and the proceeds would pay the commission of D on the service k and pay the investor as profit.

i. SEC claim: this needed to be registered b/c it was an investment k b/c investors gave money in exchange for a pro rata share of the grove (% of profits). They took something of value in exchange for expectation of profit

ii. Holding: Howey needed to register as a security under ’33 Act- this was an investment k. Court looked at the economic nature of the enterprise. It was no defense that this was a good deal.

iii. Howey should be applied flexibly- not literally (want to look at Congress’s intentions)c. Howey Test: A security is any contract, transaction or scheme where a person:

i. INVEST SOMETHING OF VALUE (give over $$ w/expectation of profits); AND1. Desire to get $ must be the primary reason you take the action

a. Profit : capital appreciation due to investment OR participation in earnings from use of investors funds

2. Use/Consumption Test: If you give $ motivated by desire (intent) use or consumption of goods or services not investment k needs dispassionate investment of $

a. US Housing v. Foreman: Tenants had to buy shares in management in order to rent apartment in a co-op. When they sold the apt, they received the amount they paid for the stock. Not security: substance over form

i. Fails Howey: did not invest $ b/c the $ was to buy apt, not invest in stock; No expectation of profit- any appreciation on investment would be on the apt, not the stock

ii. Not everything called a ‘stock’ is a stock: but not an investment- this was a refundable deposit on an apt

b. Jaguar Hypo: If pay $ to get car now intend to use & not stock; v. paying deposit to fund production of cars in 3 yrs pay the balance but you can sell it instead investment purposes (marketed by seller as investment for profit) & stock

i. Intent of Seller is what controls: BUT if it is a security for 1 person (Jaguar) it may taint the definition of security for others

3. Economic Reality Test: look at substance over form (Howey, Foreman)- calling it “stock” does not mean it falls under ’33 Act- Name is not dispositive

a. Characteristics of stock: (1) negotiable, (2) confer voting rights, (3) can appreciate or depreciate in value, (4) can be pledged or encumbered, (5) entitled to dividends

b. Teamsters: noncontributory compulsory pension plan is not an investment k b/c of economic reality- employee sells his labor to make a living, not an investment. It is

the employer who makes the contributions to the investment. Also, profits not dependent on efforts of others.

ii. In a COMMON ENTERPRISE (investors dependent on either each other or the promoter for a return on their investment); AND

1. Two Types of Commonality: Circuits are split which is neededa. Horizontal Commonality (higher standard- Howey): requires a common enterprise

among a “class”/multiple investors, all who share equally or generally in the success of the venture investors have common goal, similar relationship & share in profits (all rise & fall together)

i. Commonality among investors; not between investor & promoterii. Problem of 1 Investor : Generally, 1 investor does not meet HC.

1. Exception: Posner- it is the character of investment that matters, not # of investors. If multiple investors COULD have participated and if they did, they would have all risen & sunk together, then HC is met

iii. Pooling investor funds: investors share equally in profits/losses & all rise/fall together

1. Wals v. Fox Hills: P bought condo timeshare. Court found that P made a $$ investment & relied on 3rd party efforts, but lacked commonality b/c no pooling of profits w/others.

b. Vertical Commonality (lower standard): focus on common interest between promoter and investors. If promoter & at least 1 investor share in success/failure of venture, then VC is met. (ex. Promoter will rent out lodge and take out expenses/fees, then give investor profits)

i. Strict VC: fortunes of 2 are linked- if promoter makes $, investor makes money (direct & proportionate rise/fall). Link between SUCCESS of promoter

1. Must expose to loss, otherwise absence of risk req. for security2. Ex. If you do not rent out lodge, both promoter/investor lose

ii. Broad VC (easiest): If investor makes $, promoter makes $. Promoter does not have to share in the profit/loss risk- connection between EFFORTS of promoter & success/loss of investors.

1. Ex. Promoter does not get % of profits from lodge, but gets expenses paid by investor

c. Broker: commission= horizontal v. % profits = verticaliii. Is led to expect profits solely (predominantly) FROM THE EFFORTS OF OTHERS

1. Predominantly (not solely anymore- SEC v. Kascot): must rely on substantial efforts of others (non-investors) to affect the value (success/failure) of your investment

2. Efforts must occur after the investment is made: if efforts exclusively before the sale, then NOT a security

a. SEC v. Life Partners: D matched investors w/AIDS patents. Patients would get money in exchange for life insurance policy today and investor became beneficiary. D got a commission. People were investing money, pooling it (common enterprise) and expected a profit, but not from the effort of others. All the efforts were pre-sale. After that, just waited for them to die.

3. Others - Must be the party the investor is dealing with, not a third party4. Fixed Income: investments that give fixed, instead of variable, returns can STILL be

investment Ks if there is effort from othersa. SEC v. Edwards: D sold stakes in payphones that would give fixed return. This

investment met the Howey Testd. Howey Test Limitations: If it passes Howey test it IS a security

i. If it does NOT meet Howey, it may still be a security through other definition: ii. What does NOT matter : (1) degree of Risk, (2) creativity of instruments, (3) private v. public, (4)

whether there was a prospectus

iii. Marine Bank v. Weaver EXCEPTIONS: bank-issued CDs insured by FDIC- not security b/c FDIC insured and banking laws contravene. Congress, in enacting securities laws, did not intend to provide a broad federal remedy for all fraud

1. Better Regulatory Scheme: Is there an alternative regulatory scheme available and better suited to deal w/the given transaction? NOT a security b/c no congressional intent to be regulated by 2 agencies (ex. Banking laws, ERISA & pensions- Teamsters)

2. Uniqueness: Is the deal so unique that it does not attract investors (only 1 other person) NOT a security (ex. Barn- no one else could share in it, extremely small universe of investors)

a. Inefficient to require registration- economies of scaleiv. “Stock”: Presume it to be a security, but apply Howey & Foreman tests

1. Landreth Timber v. Landreth: overruled SOBD & said “stock is stock” so it is a 2(a)(1) security this does NOT overrule economic reality test of Foreman & Howey

a. Sale of Business Doctrine: A sale of 100% of stock of a business is not the sale of a security b/c you are selling control & cannot be selling efforts of others, so it is not an investment k

b. Intent: Sec laws should protect all stock purchasers, even if for 100% of corpsc. WORK AROUND: if you sell all the assets/liability of a corp to a buyer not a

securities transactione. Partnerships as Securities: 2(a)(1) does not mention “partnership”, but the structure may determine if it is a

security or not under Howey (turns on relying on efforts of others)i. General Partnership : all partners can manage business and personally liable for debts NOT

Securities b/c individuals have the ability to manage the business, even if they choose not to no efforts of others

1. Economic Reality Test : Management ability must be realistic (naming is not dispositive) does not matter if you choose not to exercise authority, as long as you could- so if it is a true partnership, it may be a security

ii. Limited Partnership : only 1 person can manage/bind the business & everyone else is like SH generally IS a security b/c investors must rely on efforts of others

f. LLCs as Securities: (1) If members have significant input & management authority NOT security b/c efforts of others fails; (2) If members are passive it IS a security

g. Real Estate as Securities: Real estate is NEVER a security, but the business transactions surrounding the deal (expectations of parties) may turn it into a security

i. SEC Release 5347 : ANY the following will aid in a condo (purchased directly from a developer) being an investment contract: emphasis on economic benefits derived from managerial efforts; offering of participation in a rental pool arrangement; unit must be offered for rental at any time in the year, use an exclusive rental agent, or otherwise restricted in occupancy or rental of the unit.

ii. Hocking v. Dubois: P buys condo from owner on secondary market, not developer. Broker told P the condo could be put in the pool & rented out.

1. Holding: IS a security created by broker in the aftermath, largely due to the rental pool k (offering all maintenance, fees, efforts in 1 package) making profits contingent on the efforts of others- horizontal commonality. Cannot get services separately

h. Notes as Securities: Debt (promise to pay something back) generally securitiesi. Notes, like stocks, are included in 2(a)(1) definition: presumption that it is a security but do the Reves

Test (ASK JALIL- DID NOT DO IN CLASS) (ALSO APPLY HOWEY??)ii. Two Types of Notes : intent of parties determines if it is a security (some are, some are not)

1. Investment Notes: long term (more than 1 year) rooted in projects such as capital improvements, expansion, or general business they ARE securities (bonds, debentures)

2. Commercial Notes: short term (less than 1 year) to finance short term asset (usually borrow against accts receivable or inventory) NOT securities

a. Requiring registration of these notes would restrict business too much4. Securitization: conversion of non-security item into a security (like Howey) through bundling of them in a trust &

selling the interests of that trust (ex. MBSs, A/R)a. Scotch Example : Scotch ages in oak barrel distillery for 12 yrs; can’t sell it, so make security out of it.

i. Buying 50 barrels of scotch is NOT a security, but if create a trust and sell interest in the trust (say 10 investors, each $1000), then the trust buys 50 barrels of scotch from the distiller and the distiller uses money to make more scotch, etc.

ii. Once barrels are ready and sold, the trust pays off all expenses and returns money to investor at say double the money invested this is securitization & security if it passes Howey Test

1. Investment of money: people buy interests in the scotch expecting a return on investment, not to consume the scotch

2. Common Enterprise:a. Horizontal: if something happens to scotch, they all lose; share portion of profits in

the success of the batchb. Strict Vertical: success of investor & ager are directly liked to success/failurec. Broad Vertical: If investor makes money, promoter does

b. Examples of Securitization:i. Pass through: pooling residential mortgage & selling undivided interests if the value is derived from

the management of othersii. Grouping government bonds together and sell an interest in them (bond on its own is not)

iii. MC/Visa receipts: citibank packages security receipts and securitizes them. For every billion $ on their balance sheet, they sell interest in this to investors. For the MC receipts that are not securities, MC will sell interest in them

iv. Mutual fund: put bundle of securities (GM, Coke) together and sell interest in the fund (known as a separate security)

PUBLIC OFFERING1. Definitions

a. Issuer: any person (company, enterprise, entity) that issues securitiesb. Primary Offering: any offering of securities by issuer itself (public of private)- covered by ‘33

i. Public Offering: any time issuer offers securities after IPOii. Private Offering: technically non-public

iii. Initial Public Offering: 1st primary offering to publicc. Secondary Offering: offering by someone other than the issuer (insider) who issues securities of that

company- covered by ’33 Act & must register or be exempt under 144, 4(1 ½) or Reg Ai. Insider: control person, affiliates (CEO, board, majority SH)

d. Secondary Trading: trading securities in open market by average person (NYSE, NAQDAQ)- nothing to do with offerings b/c already in public- ’34 act

2. SECTION 5 of the ’33 ACT : foundation of the act- everything else is commentarya. Rule: Absent some exemption, it is unlawful to offer a security unless registration is filed w/the SEC &

unlawful to sell/buy a security unless registration statement is in effecti. Registration: register an offer with the SEC, not the stock

b. Theory of ’33 Act: consumer protection & disclosure. Want investors to make well-informed decisions based on accurate info. ’33 Act was created to regulate market and convince consumers to invest by ensuring the market is adequately financed

c. § 4(1): § 5 does NOT apply to any person other than the ISSUER, UNDERWRITER, & DEALERi. Exempts ALL Secondary trading (getting rid of 90% of trading)

3. Section 5 Text :a. It shall be unlawful: criminal ramifications- jail, fineb. For any person: 2(a)(2) person- corporation, individual, partnership (human, entity, trust, etc.)

i. § 4(1): § 5 does NOT apply to any person other than the ISSUER, UNDERWRITER, & DEALER1. Exempts ALL Secondary trading (getting rid of 90% of trading)

c. Directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails: for constitutional challenges

d. SECTION 5(A): Unless a registration statement is in effect...to advertise or sell said securitye. SECTION 5(C): to offer to sell or offer to buy through the use of any medium or any prospectus or

otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8

i. Once registration statement is filed, but before it is effective, you can make offers to buy or sell

ii. BUT before registration is in effect, can’t finalize those offers to buy or sell4. Registration Statement : ‘disclosure statement’ It is a registration of the OFFERING, not stock/security

a. 2 Parts: (1) Prospectus: disclosure document/sales brochure that is used to market the security- must comply w/§10 ; (2) Housekeeping documents for SEC

i. Forms:1. S-1: essay questions- tell about the company2. S-2

ii. Only in effect for 9 months before info becomes staleiii. Only has to include info going back 5 years (if it existsiv. Reading Level: plain English at NY Times reading level (no jargon)

b. Theory: Consumer protection & making informed decisions based upon the truthi. Risk does not matter

c. 4 categories of info that MUST be included: (1) info bearing on the registrant; (2) info about the distribution and use of proceeds; (3) description of securities of the registrant; (4) various exhibits and undertaking; anything else material to an investor

d. Standard for Drafting: Materiality truth is not the standardi. Statements cannot be materially misleading or make a material omission

ii. Tension: want people to buy stock, so do not want to put bad stuff in. But if you do not disclose, could be sued later

5. Registration Process : Three Periods in Filing Process: Pre filing, SEC, Waiting Period, Effectivea. General: Nothing is actually registered

i. Draft of RS submitted electronically via EDGAR. SEC reviews & comments (comment letter but no verification of merits). Issuer makes changes (back and forth up to 5 times)

1. Comment Letter: SEC response based on analysis of registration statement- tells issuer of any deficiencies in the RS that SEC believes needs to be corrected

a. Approval of RS by SEC is not an approval of the offering2. NO Merit review: SEC doesn’t verify all the info is correct. Disclaimer on all prospectus’s

that SEC review does not have the means to sign off on it allii. Once comments & amendments are incorporated, registration statement is declared effective those

securities can be lawfully sold to the public via §5(a)- before could only offer under 5(c)iii. SEC CANNOT refuse to declare registration effective, but can keep stalling/commentingiv. SEC Filing fee: $5/share

b. PERIOD 1: PRE-FILING PERIOD (Quiet/Consistent Period)- period between when issuer is “in registration” & the filing of the RS no offers, sales or market conditioning §5(c): Cannot make offer until RS has been filed

i. Consistency: only permitted to act in a manner consistent w/your past practices clear all public communication through counsel & refrain from giving forward looking statements

1. Can make factual statements 2. SEC 5180- “there is no basis in securities acts or in any policy of the SEC which would

justify the practice of non-disclosure of FACTUAL information by a publicly held company on the grounds that it is ‘in registration’.”

a. Public companies have a legitimate reason to disseminate info and make announcements; as they always disseminate information,

b. Private companies have far less justification to make announcements/facts “in registration” unless they’re in the news for some other reason

3. §2(a)(3): Negotiations w/Underwriters: these are okii. Conditioning the Market : insider attempts to arouse public interest in stock as a prelude to the

offerings pre-conditioning is a disguised offer in violation of § 51. Loeb Rhoades: D was going to underwrite an IPO and began advertising how great the stock

was BEFORE a registration statement was filed to get the market excited. Not allowed b/c D was garnering interest in the company

2. Any efforts promoting the sale of stock, even if indirect, intended to pre-condition the market prior to registration is deemed making an illegal offer in violation of § 5(c)

iii. Rule 135: Safe Harbor (only during pre-filing period) allowing issuer to publish a notice that it intends to make an offering (w/o being a disguised offer)- can’t be an ad

1. Mandatory items : must state that an offer may be made only by prospectus and the info you are issuing is not an offer (boilerplate legend)

2. Permissible items : can include name of issuer, title, amount and basic terms of securities to be offered, timing of the offer, amount of the offer, whether the offer is directed to a particular class of purchasers (public or private), brief purpose

3. Prohibited Items: CANNOT mention underwriters or offer price (can change)iv. Examples of what can be done during this period:

1. Press release is ok, just not up to an offer- Rule 135 safe harbor2. Publication of info and statements- may not be allowed (conditioning the market)3. Distribution of brochure talking of future potential- illegal4. Speech by CEO describing company- is ok, if not arranged in contemplation of public

offering & cannot hand out printed materials5. Annual reports- ok if normal type, always used and material didn’t assist in offering6. Switching places you normally advertise may be a problems- could be conditioning7. VP is allowed to talk w/I-Bank about the offering & can send agreement w/underwrites

c. PERIOD 2: WAITING PERIOD - period after 1st draft of RS is filed and until RS if effective (back and forth w/the SEC)§5(a): w/RS filed, selling efforts can commence via § 10 Preliminary Prospectus

i. Oral offers/statements allowed: oral communication to solicit an ‘indication of interest” on part of the buyer is ok NO binding offer/acceptance can be made & no sales consummated or $$ accepted until RS is declared effective can orally say anything

ii. Writing: 3 allowed- Preliminary prospectus, underwriter negotiations, rule 1341. Preliminary Prospectus (§10) (red herring): Draft prospectus distributed by issuers in trying

to create interest/market for upcoming offeringa. RED Herring: MUST contain in red (vertically & horizontally) a notice that it is not

finalized or the official prospectusb. Circulation : must circulate widely- final must have been in circulation for at least 48

hours before effectiveness w/substantially same infoc. Amendments : must send new prospectus if amended to go effectived. §2(a)(1) deems any written communication to be a prospectus if BEFORE effective

date & must comply w/ §5 and §10e. Must contain substantially the same info as the official prospectus- may only exclude

pricing info2. Rule 134 : Safe Harbor (only during waiting period) allowing issuer to publish a notice &

offer & who UW will be- cannot mention pricing info & MUST include boilerplate legend that RS was filed but sales can’t be made before effective date

iii. Timing: § 8(a): SEC has 20 days to declare RS effective (but not true)iv. Examples of what can be done:

1. Issue press release announcing filing of RS, the offering & purpose, identifies underwriter and gives statement of earnings per share- no good b/c any offers must be made through prospectus or orally

2. Broker at underwriter tells someone on phone to purchase the shares and sends prelim prospectus. This is ok- it is a solicitation of an indication of interest

3. Broker mails form to someone w/a note saying it is a good by- no good- writing4. Check sent to the broker- no good, only solicit indications of interest5. 3rd party underwriter not involved places info on website about the offering. OK b/c not

involved6. Company links to the above UW- not ok7. UW sends a letter to customers describing other stocks of company. OK bc unrelated8. Broker mails prospectus to everyone she knows & calls them. OK

d. PERIOD 3: POST-EFFECTIVE PERIOD- after RS becomes effective formal offers can be made/accepted and sales many be consummated

6. MATERIALITY OF INFORMATION IN PROSPECTUSa. Standard: materially misleading truth is not a defense

i. Statement cannot be materially misleading in the totality of the RS, including material omissions (even if it is technically true, it can be misleading)

1. Ex. Saying CEO is 61 instead of 63- it is a lie but not material2. Ex. Saying CEO is 49 but she is 19- it IS material (not truth + misleading + materially

misleading)ii. Anything material must be included

1. An (omitted) fact is material (needs to be in prospectus) if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to invest (TSC v. Northway)

b. What Rises to the Level of Materiality? It must be in prospectusi. Reasonable Investor Standard – objective standard of a “reasonable investor” NOT based on

subjective preferences of an individual investor.1. Ex. Flower co dyed flowers green for holiday but owner said he didn’t. This is not material-

need to be reasonable to investor, not individualii. 5-10% Rule of Thumb – financial misstatement is material if it deviates by MORE than 5-10% from

actual info of net assets, earnings, etc. [NOT bright line test or supported by SEC – should not survive SJ].

iii. Market Test (minority approach) – If we assume market is efficient and all investors are reasonable, then gauge materiality by if price fluctuates when info’s released. Proposes that effect on price should be measure of materiality, not some arbitrary standard.

c. Buried Disclosure Doctrine – even if disclosed all material info, it must be clear, readable, and sufficiently prominent for its relative importance (buried disclosure is NO disclosure).

i. Applies where all substantive info has been set forth, but in such manner that the mosaic can only be assembled w/great difficulty and advanced knowledge.

ii. In re Merck & Co – Filing is NOT materially misleading if the magnitude of the problem could be deduced by a couple of mathematical calculations and an assumption.

d. FUTURE EVENTS & Materiality – what future events are so material to be included in prospectus.i. Probability/Magnitude Test – depends upon balancing of both the indicated probability the event

will occur and its anticipated magnitude in light of the totality of the company activity. (Basic v. Levinson- merger discussions- still disclose even if it may stop the deal)

1. Jalil Scale: Make up a number- disclosure standard is 125 (25% probability); Assign magnitude & probability 1-100, does the combined likelihood exceed 125%? If so, then it should be disclosed.

a. HYPO: Golfing w/Bill Gates and, after a good round, he says he’s gonna buy my company.

i. Magnitude of this event, to me, would be 100/100 but the probability is really only 5/100. Thus, 105 < 125, meaning I DO NOT disclose.

b. Now Bill asks for more info but we know looking at other companies: 100 + 20 probability= 120 (no disclosure)

c. Now Goldman calls and says Bill asked for a recommendation. 100 + 30= 130- disclose only that they have been approached by ibankers, not that they are being bought by Microsoft

d. HYPO: I sell trucks for a company & customer says he’ll buy one from me (I have 116 trucks) for 1M

i. Probability is 100/100, but the magnitude, relative to the whole company, is only 3/100. Thus, 103 < 125 and I DO NOT disclose.

e. HYPO: CEO has pancreatic cancer & 2 yrs to live. Wants to wait to disclose till he has a transition team in place.

i. MUST disclose ASAP, can’t wait till team in place.e. Obviousness Doctrine – sufficient public/market info enabling a deduction of obvious information that was

not disclosed means that this failure CANNOT serve as grounds for liability.do not need to disclosei. Wieglos v. ConEd – constructing powerplant & it’s obvious it could have cost overruns. B/c it

happened so many times, there’s no need to put in the prospectus.ii. Ex. If it was raining, jury can assume the street was wet (so take judicial notice of it)

iii. Truth on the Market – misstatement isn’t not material b/c savvy investor knew prospectus wrong and stock price moved accordingly – efficient market accounted for inaccurate info.

f. MUST disclose even if bad for SHs .- hurting SH value is not a defense against disclosure

i. HYPO: D finds out her factory encroaches on neighbor & if find out will have factory torn down (costly for SHs) – no matter b/c info is material so must disclose in prospectus- even though he claims he has fiduciary duty to SH- it does not matter.

TRANSACTIONS EXEMPT FROM § 5 REGISTRATION

ISSUER can use CONTROL PERSON can use

REPORTING COMPANY can use

PRIVATE COMPANY can use

INVESTMENT COMPANIES can use

§3(a)(11) Rule 147§3(b) Rule 504§3(b) Rule 505§4(2) Rule 506Reg A (only non-public co.) §3(a)(9)

Rule 144 (only public co.)§4 (1 ½)Reg A (only non-public co.)

§3(a)(11)§3(b) Rule 505§4(2) Rule 506

§3(a)(11)§3(b) Rule 504§3(b) Rule 505§4(2) Rule 506Reg A

§4(2) Rule 506

1. Exempt Transaction : offering exempt from registration process of §5 and therefore §10 liability for registration statements only applies to primary offerings

2. Introduction: §5 states that you cannot offer security w/o it being registered—Exceptions:a. §2(a)(3) Underwriter Negotiations Permitted: exception to definition of offer- allows agreement between

underwriter & issuer so that they reach agreement before registrationb. §4(1): Registration requirements of § 5 do not apply to transaction by persons other than issuer, underwriter,

or deal w/r/t that offering. § 5 does NOT apply to secondary trading, but DOES apply to secondary offerings (someone other than issuer)

c. §4(2): registration requirements of §5 do not apply to transaction by an issuer not involved in a public offering (non public offering= private placement

d. §3 (Exempted securities- drafting error): 2 major categories: (1) exempt securities (US treasury bonds, etc), and (2) certain exempt transactions (if you sell a security this way, the particular offering is exempt)

3. DOCTRINE OF INTEGRATION: SEC will integrate 2 or more separate offerings & treat them as 1a. Prevents issuer form improperly avoiding registration by artificially dividing a single offering so that

exemptions appear to apply to only individual parts but would not as a wholeb. Five Factors of Integration – none are dispositive- subjective

i. Are the offerings part of a single plan of financing? (i.e.: what is money raised for? Same purpose?)ii. Do they involve the same class of securities? (i.e.: both common stock/debentures)

iii. Are the offerings made at or about the same time?1. ***If offerings are a 1+ years apart, SEC will NOT integrate. If offerings x < 6 months apart,

SEC WILL integrate. If offerings are 6 months < x < 1 year apart, look at the 5 FACTORS.iv. Is the same type of consideration received? (i.e.: 1 for cash but other is a stock exchange for

merger).v. Are the offerings made for the same general purpose?

c. EXAMPLES: i. Omega wants to do a §3(a)(11) and, w/in 6 months, do a validly registered public offering under §5.

1. If integrated, §3(a)(11) exemption is blown due to the interstate offering and §5 registered offering is blown b/c of solicitation via §3(a)(11) offering prior to filing registration statement.

ii. Omega offers stock in NY in May under §3(a)(11); then do a registered offering the same day in all 50 states. The common stock is used to purchase equipment, and the note offering is to hire more salesman.

1. MAYBE no integration b/c they don’t involve the same security or class thereof, but they are offered at the same time. They receive the same type of consideration, but arguably some are making equity investments while others debt. They are not used for the same purpose

iii. 147 and 506 made within 2 days- the general solicitation allowed in 147 destroys the 506iv. Made legal section 5 public offering for 10M shares common stock & next day made a 506 for 1M

shares. If 1 big offering, the shares sold w/o disclosure destroy the others

v. Company A does a registered offering and then a few months later does a Reg D (505) for the same exact stock and all. The Reg D is blown because the general solicitation you did [for the § 5 Offering?] (and perhaps the number of unaccredited investors you offered to) has blown the condition for the Reg D. But the registered offering is ok (no gun jumping problem since the Reg D was done after the registered offering)

vi. Company B does a Reg D (505) and then a few months later does a registered offering. The Reg D is still blown because of the advertising and the unaccredited investors, but now the registered offering has a gun jumping problem – they’ve consummated offers before they were effective.

vii. If I do a 3(a)(11) offering and a public offering within six months of a registered offering and the SEC integrates the two offerings, both offerings are in trouble, the 3(a)(11) offering because the registered offering was made interstate and the registered offering because my solicitations with respect to the 3(a)(11) offering may violate § 5’s limitations on solicitations.

viii. Suppose you offer common stock in NY in Sept. under 3(a)(11). Then you also do a registered offering of notes the same day in all 50 states. The common stock is used to purchase equipment, and the note offering is to hire more salesman. To argue that the two offerings should not be integrated (thus denying the benefit of 3a11 as to the common stock offering). They don’t involve the same security or class thereof, but they are offered at the same time. They receive the same type of consideration, but arguably some are making equity investments while others debt. They are not used for the same purpose

Whether the two+ offerings . . . Integrate Not Exempt Don’t Integrate Meets Exemption

a) Constitute a single plan of financing Both for capital for factory

One for warehouse, one for business operations

b) Involve the same class of securities. Both common stock One common stock, other indentures.

c) Are made at or about the same time. Both w/in 6 months. If January and October.

d) Include the same type of consideration received. Both for cash.

One for cash, other offering for securities.Note: this speaks to intent of investors: ITDI v. equity.

e) Are used for the same general purpose.

4. INTRA-STATE EXEMPTION: § 3(a)(11): any (offering) of a security “which is part of an issue offered and sold only to persons resident within a single state or territory” do not need disclosure or file registration statement but cant make affirmative misrepresentations (blue sky state laws)

a. § 5 Does not apply if securities are (1) offered/sold in a single state, and (2) issuer resides & does business in that state OR is incorporated & doing business there

i. CPIA can use this even if they are not residents of the state of the issuerii. No limit on how many people involved OR whether public/non public- general solicitation OK but

must contain legend that limited to in state residentsb. Rationale: political compromise for states rights advocates in congress when ’33 act passed- who did not want

fed government regulating securities that were wholly w/in a single statec. Strict Enforcement : 1 offer/sale outside of state & you have “blown the exemption”

i. Blown exemption: thought 3a11 was available to you but did not structure it properly and did not comply w/§ 5 when I should have

d. RULE 147 Safe Harbor: how to structure an offering so that issuer can offer/sell securities w/in the state to be pursuant to 3(a)(11) & not make disclosure (not the only way to do it but the best)

i. ISSUER: must be a resident, or have your principle place of business in, and doing business, within the state in which all offers and sales are make

1. Issuer is a resident of a state via incorporation/organization: ANDa. Corporations & Limited Partnerships: resident in the state in which it is incorporated

or organized

b. General Partnerships: resident in the state where its principal office is locatedc. Individuals: resident of the state where he has his principal residence/domicile (intent

to remain)d. Cannot use 3a11 if business is incorporated in 1 and main office in another

2. Issuer does business in a state where BOTH:a. Principal Place of Business/Headquarters areb. Doing Business (Triple 80% Test) : an issuer is deemed to be doing businss in a state

if: 80% of its gross revenues are derived from that state; 80% of its assets are in that state and; 80% of the proceeds of the offering are to be used in that state

3. Must only be offered & sold to residents of that stateii. LIMITATIONS ON RESALE (to prevent sham sales): securities must be held by residents of the

state for 9 months (starting at the date of the last sale and when last payment received)1. If even 1 purchaser sells outside the state, the entire exemption is blown2. Tacking: 9 month period will tack back to the date of issuance if the purchaser transfers the

securities to someone in the state3. CANNOT put a provision in the sale that the security can’t be resold unless in that state.

a. Sell it to people but keep it in your account (as an escrow) till 9 months after the sale.4. Moving – if they had intended to move after sale, then won’t be upheld. But if it had come

up suddenly, then sale will be permitted.iii. Underwriters – need NOT be a resident of state of offering (i.e.: same state as issuer).iv. INTEGRATION: 6 month safe harbor- rule on Rule 147

5. § 4 EXEMPTED TRANSACTIONSa. §4(1): §5 does NOT apply to transactions by any person other than issuer, UW, dealer

i. Allows secondary trading after a registered offeringb. § 4(2) (Private Placement Exemption for ISSUERS): §5 does not apply to transactions not involved in any

public offering (used often) do not need to be registeredi. Opposite of public offering: non-public (not private)

ii. “Public”: anyone who needs protection of the Securities Laws1. Person does not need protection if they have (1) sophistication (w/r/t financial matters) and

(2) access to information about the issueriii. SEC v. Ralston Purina: D wanted to sell stock to its employees pursuant to §4(2) private placement

exemption—was not allowediv. Ralston Purina Test for §4(2): 3 requirements size of offering does not matter (no # limit)

1. Sophistication of Investor: Is the investor financially sophisticated enough to make the investment decision w/o receiving a prospectus?

a. Standard: Whether investor can understand and evaluate the nature of risk upon the info supplied to him, not whether they understand the latest techniques of corporate finance riskiness does not matter, just understanding

b. Education: not dispositivec. Wealth: not a replacement for sophistication

2. Access to Information: W/o the info, sophistication is useless. Satisfied in 2 ways:a. By virtue of ones position w/the issuer : only director/officer, not employees no

discosure neededb. If you do not have access, must be given written disclosure : must be the same

disclosure he would have received if the issuer had prepared a registration statement materiality standard of reasonable person

3. No General Solicitation: Issuer cannot generally solicit for a private offering (b/c offering to non-sophisticated person would blow the exemption) so no advertising

a. Issuer must reasonably believe in good faith through prior info/relationships that the offerees are sophisticated; SEC prefers prior relationship- can use investment bankers to make introductions to potential investors

v. Examples:i. Sell to one financially unsophisticated person, it’s public offering and need to register.

ii. Sell to 10k business school professors, then offering is non-public (§4(2) exemption)iii. Sell to 100 PHD in math, it’s probably a public offering- not sophisticated in finance.

6. §3(B): SEC POWER TO EXEMPT ANY TRANSACTION < $5 MILLION7. REGULATION D: (RULES 501-508) Safe Harbor for §4(2)

a. Intro:i. Double Duty of Reg D

1. Prescribes 2 methods for exercising plenary power of SEC to set rules on how to structure an offer/sale of securities exempt from §5, under §3(b) [504, 505]; AND

2. Provides a safe harbor for 4(2) private placements [506] pursuant to Ralstonii. Purpose: Small Business Initiatives (504, 505, 506): inexpensive, efficient ways to raise capital

iii. Regulation= a series of rulesb. Aggregation : Only looks BACK

i. In a §3(b) offering (Rule 504 or 505, NOT 506 b/c it’s a §4(2)) must look back 12 months to ensure in the aggregate that 3(b) offerings don’t violate the $5M maximum of §3b OR the maximum of each individual rule

ii. HYPO: If you do a $400k Rule 505 offering 1st, then you can only do a maximum of $600k on a subsequent Rule 504 (b/c the total limit is $1M). However, after doing these first 2 offerings for a total of $1M (Rule 504 max), you can still do a third offering under Rule 505 for $4M (to hit the Rule 505 max).

iii. HYPO: If you do a $4M Rule 505 offering 1st, then you C/ANNOT do a subsequent Rule 504 offering b/c it’s already maxed. However, you CAN do a 2nd Rule 505 offering for $1M (to hit the Rule 505 max).

c. RULE 502: These are general conditions applicable to Reg. D transactions as indicated in eachi. Menu of requirements 504, 505, and 506 pick and chose from

RULE 502 Menu 504 505 506a) Integration (6 mo Safe Harbor)

X X X

b) Info Req / “Disclosure” X Xc) No General Solicitation X* X Xd) Restricted Securities (time) X* X X

*Quirky exceptions that ALLOW General Solicitation and make Securities NOT restricted based on State Blue Sky Laws

Regulation D (encompasses Rules 501-508) – SAFE HARBORS Rule 501 Creates a series of definitions to be used in the rule.

1. “Accredited Investor” – any person which comes within the following categories: a bank, insurance company, investment company, pension plan, profit share plan, a trust, corporation, partnership w/total assets more than $5M, director/officer/general partner of issuer, individual w/net worth w/spouse exceeds $.51M, individual whose income exceeds $200K or w/spouse exceeds $300k.

a. These are “sophisticated investors” ONLY for the purposes of Regulation D; does NOT extend to §4(2) & Ralston Purina. Kind of violates Ralston Purina, but doesn’t matter b/c it creates the bright-line necessary for a safe harbor to be effective.

2. 501(e) – Calculation of number of purchasers – for purposes of Rule 505, the following persons are excluded: ANY accredited investor.

Rule 502 General conditions to be met by ALL Regulation D offerings.1. 502(a) – Integration- (504, 505, 506)- 6 month safe harbor in either direction

a. ***If integrate a §3(a)(11) w/REG D, it corrupts the exemption b/c Rule 147 can generally solicit customers while §4(2) offerings cannot.

b. Use FIVE FACTORS OF INTEGRATION if the issuer does not use the safe harbor

2. 502(b) – Disclosure (Information Requirements) – if issuer sells securities under Rule 505 or 506 to any purchaser that is NOT an accredited investor, it shall provide the following:

a. b. NO DISCLOSURE needed if to accredited investors or via Rule 504.b. 505/506: no disclosure required if accredited investorc. Non reporting issuer (non-public): Issuer must give investor same financial info if it would have filed the registration statementd. Reporting Issuer: issuer must give investor copies of SEC reports (AND for 505/506, must give opportunity to for Q&A- but not for 504)

3. 502(c) – No General Solicitation: Must be some kind of preexisting personal relationship b/w the investor and the issuing agent NOT via radio/TV/magazine/etc.4. ***502(d) – Restricted Securities – securities bought under Reg D CANNOT be resold immediately (there are certain rules in place- limited resale) see Rule 144.

Rule 503 Notice requirement called “Form D” that must be filled out every time Regulation D is used (is an informational filing, NOT scrutinized) & submitted w/in 15 days of first sale.- no disclosure or approval, just for statistical purposes

**Rule 504 (doing a 504)

Offers/sales that satisfy 504(b) EXEMPT from provisions of §5 under §3(b) (Restricted Securities) Applies when:

1. Issuer is NOT a public/reporting company per §13 and §15(b) (securities not traded on stock exchange) & is NOT an investment company (aka: mutual fund) & not blank check company2. Issuer complied w/Rules 501 & 502(a), (c), & (d) if conflicts w/state law, then STATE law controls3. ***DOES NOT need disclosure.4. ***Offering price is LESS than $1M count up all §3(b) offerings (504, 505, Reg A).5. No limitation on investors need not be sophisticated b/c this is a 3(b)

**Rule 505 (doing a 505)

Offers/sales that satisfy 505(b) and are NOT by an investment company (mutual fund) are exempt from §5 under §3(b) (PUBLIC offering) (Public reporting company can use). Applies when offers/sales of securities:

1. Issuer complied with Rules 501 and 502 (***ALL – including disclosure).a. ***Rule 501(e), CANNOT sell to x > 35 non-accredited persons (NOT including accredited investors).

2. ***LESS than $5M. (count up all 3(b) offerings- 504, 505, Reg A)3. Not an investment company (not limited to non public company like 504)

**Rule 506 -SAFE HARBOR under §4(2) (PRIVATE offerings) Offers/sales of securities are transactions NOT involving ANY public offering under §4(2) (in the world of Ralston Purina) if:

1. Satisfy 501 & 502 – ALL2. ***Rule 501(e), CANNOT sell to x > 35 persons (NOT including accredited investors).3. ***Each purchaser who is NOT an accredited investor must demonstrate that he is capable of evaluating the merits and risks of an investment (be sophisticated NOT just wealthy).

a. If NOT accredited or financially sophisticated, can STILL fall under this safe harbor if they have a purchaser representative that IS financially sophisticated (broker).- just want 100% of purchasers to be sophisticated (Ralston Purina element)

4. NO dollar limit, which is probably why there’s a sophistication requirement also b/c it is NOT under §3(b), which has a $5M cap.

Rule 507 (Bad Boy Provision) issuers who have gotten in trouble w/SEC in past for failing to file FORM D may NOT use Rule 504, 505, 506 can’t do future REG D offerings.

Rule 508 SEC must construe Regulation D leniently.- “I & I”- Immaterial and insignificant deviations will not cause a violation of Red D we want them to raise capital like this (note: 502a-d are bad violations)

8. REGULATION A (MINI REGISTRATION) § 3(b) exemption for public offeringsa. Overview:

i. Mini registration: not technically registration, but disclosure documentii. Maximum amount of offering: $5M

iii. Not used as much: duplicated by 504 and 505iv. NO “No General Solicitation” Requirements can do internet advertisingv. Registration statement: issuer prepare offering statement (looks like registered offering)

vi. Limited Disclosure : less stringent than § 5

vii. Available to Insiders : unlike reg D, not limited to issuers; available to insiders (non public) up to $1.5M

b. Rule 251: Public Offered Sale Requirements will be exempt from registrationi. Issuer Requirements (251a): Must meet ALL

1. Must be a US or Canadian entity, AND2. Cannot be a public company (not subject to § 13 or §15(d)) & no reporting companies,

investment companies, mutual fundsii. Amount of Offering (251b):

1. Primary Offerings (251b): offering price cannot exceed $5M for an issuer2. Secondary Offerings (251b): Reg A available up to $1.5M for CPIA/UW

iii. Aggregation : (251b)- Reg A only integrates with other Reg A offerings performed w/in the past 12 months Ignores other §3(b) offerings (504, 505)

1. BUT 504/505 offerings aggregate w/all §3(b) offerings including Reg A w/in 12 months2. HYPO: do a $3M 505 offering 1st, then you CAN proceed w/a $5M REG A offering.3. HYPO: do a $3M REG A offering 1st, then you can ONLY proceed w/a $2M 505 offering.4. HYPO: do a 2M reg A in January and I look back for 505- reg A is a 3b and this would effect

the cap for a 505--- but for reg A only see other Reg A; so in June I can only do a reg A for 3M; but if I want to do a 505 for 2M in January and a reg A in june, I can do the whole 5M

iv. No accreditation/sophistication requirement (3(b))v. Unrestricted Securities : Reg A offerings are not restricted & may be resold immediately

vi. Integration (251c): Reg A offerings will NOT be integrated with either1. Any prior offerings, OR2. Later offerings that are: Registered; Made in reliance upon Rule 701; made pursuant to an

employee benefit plan; made in reliance on Reg S, or made more than 6 months after the Reg A offering

vii. Solicitation (251 d): Offering Conditions for Offers & Sales1. NO offers made unless Form I-A has been filed w/SEC (except rule 254)2. After Form I-A (offering statement) is filed general solicitation is encouraged or

oral/written offers via ads sophistication does not matterviii. How to Do a Reg A?

1. Prepare an offering circular (Form I-A) & file w/local SEC office2. Before it is qualified, not effective, you can make offers & advertise3. Once form is qualified, you can make sales

c. Rule 254: Testing the Water Exception: allows issuers to ‘test the waters’ to see if there is an interest in the offering before spending time/money on a Reg A offering Issuer cannot sell but if there is interest, they can proceed w/the offering and filing cannot be a sham reg A

i. Bona Fide Change of Intention (254(d)): Good Faith Requirement1. If you learn that demand for securities exceeds $5M limit, can abandon Reg A & do a §5 full

registered offeringa. Must wait 30 days after abandonment of Reg A, then do §5b. Must be done in GOOD FAITH

2. If there is little interest in Reg A & want to do a Reg D must wait 6 months due to problems of integration (& 254 only says going to a §5)

ii. Example: what if I want I find that there’s little interest in a Reg. A offering and want to do a RULE 505 offering instead? Integration tells us that the solicitation taints the RULE 505 (it is a prior offer). There is no safe harbor to jump from a Reg. A to a Reg. D offering (you must wait 6 moths under the Reg. D integration safe harbor before proceeding with the Reg. D offering)

d. Rule 260: Reg A will be enforced leniently9. REGULATION S (OFFSHORE OFFERINGS) defines when SEC will assert jurisdiction

a. Overview: Offerings outside the US are NOT subject to SEC regulations & §5 filing requirementsi. Issue: defining “occurs within the US”- Reg S defines what is NOT in the US

ii. Purpose: protect US markets from flow back of unregistered securities from abroad & prevent attempts to get around securities laws

iii. If offer targeted at US citizens living abroad as a group SEC will asset jurisdictionb. Rule 901: § 5 registration applies ONLY to offerings IN the US

i. Exception (US Targeted offering) : If offer targeted at US citizens living abroad as a group SEC will asset jurisdiction

c. Rule 901 (Offshore Offering Test): “an offer or sale of securities by an issuer outside the US if (1) the offer is made in an offshore transaction AND (2) no directed selling efforts in the US

i. Part 1: Offshore Transaction: Not in the US if:1. A buy order originated outside of the US, or seller reasonably believed they were, OR2. A trade made on the physical trading floor of an exchanged located outside of the US

ii. Part 2: No Directed Selling Efforts IN the US: any activated undertaken for the purpose of, or which could reasonably be expected to have the effect of, conditioning the market in the US

1. Includes ads in publications w/general circulation in the US; OR2. Foreign publication & during past 4 months w/avg circulation of more than 15K in US3. Exception : Permitted if ad is required under US or foreign law, contains no more info than

legally required, & states that security is not offered in the USii. RULE 903(b) (Categories of Offshore Offerings) – SEC groups all issuers into 3 categories based on

likelihood their securities will flow back to the US.- prevent sham transaction1. EACH Category must be: (1) offshore transaction + (2) no directed selling efforts in US2. Category 1 : issuer has LITTLE or NO substantial U.S. market interest. SEC will not assert

a. No substantial US market interest if: security is not quoted anywhere in US or on US stock exchange; or it is a debt security w/fewer than 300 US holders

b. Foreign issuer engaged in overseas directed offering: directed at single country or debt security directed at single country

3. Category 2 : issuer has SOME U.S. interests (foreign issuer w/securities traded on U.S. stock exchanges)a. Must put a legend on security that it must NOT be resold in U.S. for 40 days.b. ALL offering materials MUST bear legend saying that the securities are NOT registered in U.S. and

can’t be sold there w/o registration/exemption.4. Category 3 : has LOTS of U.S. market interest (U.S. issuer w/securities traded on U.S. stock exchanges)

a. Securities issued may not be resold in U.S. for 1 year. (debt cannot be resold for 40 days)b. ALL offering materials MUST bear legend saying that the securities are NOT registered in U.S. and

can’t be sold there w/o registration/exemption.c. Purchasers must certify that they are not a US person

iii. INTERNET Foreign Offerings – when is an internet posting NOT directed to the U.S.1. If issuer takes appropriate (precautionary) measures that are reasonably designed to ensure that U.S.

persons do NOT participate in offshore internet offerings, then the SEC will not assert j’dn. a. Options for foreign issuers offering on internet:

i. Have prominent disclaimers stating it is NOT being offered in the US; ii. Implement protections reasonably designed to guard against U.S. participation in the offer-

procedures, passwords2. If a U.S. citizen purchases securities notwithstanding protections (i.e.: uses fake ID), SEC won’t take

action UNLESS company was aware purchasers were U.S. citizens (i.e.: check drawn from U.S. bank, gives U.S. taxpayer ID number, or SSN).

iv. Integration – REG S is NOT integrated w/other valid U.S. offers.

SECONDARY OFFERINGS1. Definition: A secondary offering is an offering done by someone other than the issuer but who still must be

concerned with §5 must register or seek exemption under 144, 144(A), 4 (1 ½) or Reg Aa. Note: not the same as secondary tradingb. Transactions Covered by §5: Offerings by issuers (primary offerings) + offerings by underwriters, dealers

(secondary offerings)c. Inquiry: Who is an underwriter?d. Problems that can occur:

ii. The resale may destroy the exemption the issuer relied upon when it sold the security w/o registration1. Example: if the issuer relied upon § 4(2) and its sophisticated purchaser sold it to an

unsophisticated investor (within 1 year??), the original 4(2) transaction is blown and violates § 5

2. Example: if issuer relied upon intrastate exemption (3(a)(11), 147), and it was resold out of state within 9 months, it could destroy it for the issuer.

iii. Once the (non-public; sophisticated) purchasers resells, they become an underwriter & due to integration the original issuer loses any exemption they had in the initial offering

2. Who is an UNDERWRITER?a. §2(a)(11) Statutory Underwriter: Any person who has purchased restricted securities from an issuer with a

view to distribution of any security to the public; OR Participated or has a direct or indirect participation in any such undertaking or participates or has participation in the direct or indirect underwriting or any such taking (Ex. Merrill, Goldman)

ii. 2 Groups of Underwriters: (1) Someone who purchases from an restricted securities from an issuer w/a view to distribute; (2) someone who purchases from a CPIA w/a view to distribute

iii. 3 Classes of Underwriters: (1) Smith barney, goldman, etc.; (2) holders of restricted securities (a security not yet in the hands of the public- has not gone though § 5 registration process); (3) CPIA

iv. A VIEW OF DISTRIBUTION TO THE PUBLIC (Ralston Purina- anyone who needs protection of the securities laws) unsophisticated buyers

v. Examples 1. What if I bought shares in a valid 4(2) and turned around and sold those shares to Ma and

Pa America? am I an “underwriter”? Yes. That’s why shares are restricted. I’m what’s known as a statutory underwriter. There’s no difference between a statutory underwriter and Goldman Sachs.

2. If Microsoft does a registered offering and sells directly to me (an unsophisticated investor and therefore a member of the public) with a prospectus and I want to resell it to Ma and Pa America, I am not an underwriter. I am the public. I cannot sell it with “a view to distribution to the public” because once I have it, the distribution is over. I am not an underwriter, but a secondary trader and therefore § 5 does not apply to me.

3. If I buy securities in valid Reg D or 4(2) and then resell to the public, I am an underwriter. The securities I am reselling are restricted securities, and if you resell right away you are a statutory underwriter.

4. What if I buy under 506 and I sell to another accredited investor? Reg. D says that is not the public. It is probably okay. If you are selling to someone who could have bought in the original offering, you will not be deemed a statutory underwriter. They could have bought in the original Reg. D offering and are therefore exempt from the registration requirements of Section 5.

b. WHO IS AN UNDERWRITER? REAR VIEW MIRROR/SUBSEQUENT ACTIONS TEST look at state of mind of the purchaser at the moment he purchased- were the shares acquired w/a view to distribute OR as an investment?--> the test judges intent by your OBJECTIVE actions

ii. One Year Rule of Thumb: How long was the security held? 1. Held MORE than 1 year after primary offering SEC assumes it was an investment2. Held LESS than 1 year assumed to be for distribution & must register under §5

a. EXCEPTION: “profound & unforeseen circumstance” where you intended to hold but were forced to sell before 1 year (rare) (ex. Kid got cancer)

iii. How can the issuer ensure the security is purchased as an investment?1. Ask for an investment representation letter- include covenant that if they sell, they will be a

statutory UW per §2(a)(11) and must register2. Place legend on stock saying securities are not obtained under §5 and anyone buying or

selling must consider themselves a statutory UW and registeriv. 3 Ways to Avoid §5 Registration in resell:

1. Wait 1 year for security to ‘come to rest’2. Avoid a ‘distribution’ and use a §4(2) private placement exemption (rule 506)3. Resell using rule 144

c. PURPOSE – Congress didn’t want issuers to be bound by §5 but for it to be so easily sidestepped by a simple conveyance to someone else (an underwriter) immediately thereafter.

d. HYPO: Bought shares thru valid §4(2) or REG D & then resold them in America.ii. Statutory UW, which is why shares were restricted (no legal difference b/w GS & a statutory UW).

e. HYPO1: Microsoft does registered offering and sells directly to you (an unsophisticated investor and member of the public) with prospectus et al. and then you want to resell it in America.

ii. NOT a UW b/c once a valid §5 distribution to the public has occurred, they are all just secondary traders and do not have to register under §5 (ONLY applies to financial firms).

3. CONTROL PERSONS, INSIDERS, AFFILIATES (CPIA) “issuers” per §2(a)(11)a. §2(a)(11) (Issuer) – anyone in direct/indirect control of issuer so as to have power to compel registration

for statutory purposes, these “issuers” include control persons, insiders, and affiliates (CPIA).1. CPIAs are NOT issuers themselves, it is just as though they were for §4(1) purposes only NOT others

(Ex. Buying from Bill Gates it is as if you bought from Microsoft itself.)a. ***Anyone buying from CPIA is deemed to be buying from an “issuer” as per §2(a)(11) and, thus, is considered to be a UW so they MUST register to sell (unless held for 1 year).

2. ***Issuer company MUST file a §5 registration on behalf of CPIAs whenever they sale, regardless of how long they held it or how they acquired them including not via primary offering (i.e.: stock market).- issuer is in the best position for disclosurea. If a CPIA goes into the public and buys securities sold in a registered offering, the CPIA still can’t

resell these securities w/o registration or an exemption from registration.v. Who is a CPIA?

1. Directors and Senior Management ALWAYS2. Controlling SHs question of fact

a. Per se own greater than 50% of outstanding stock.b. Can be someone that owns LESS than 50%, but is still relatively in control.

i. E.g: Dupont was 25% GM owner, other 75% diffusely held Dupont IS control person.; BUT: I own 40% and X owns 60%- may not be a controlling SH

3. Others someone w/the power to compel the issuer to file a registration statement. a. Misnomer – b/c every member of BOD is a control person even though one director alone may not be

able to make compel issuer and make the decision to file.b. BETTER TEST whether individual is part of a control group (senior management/directors)

vi. ***ONLY way CPIA can sell stock of that firm w/o §5 registration is Rule 144, §4(1)(1/2), and REG A. CANNOT use Reg D, etc.

1. ***If a REG A, can only do so up to the $1.5M limit for CPIAs and this REG A is aggregated towards the $5M limit for the issuer company, so they only have $3.5M left in that 12 month period.

b. §4(1)(1/2) EXEMPTION created by SEC and extends non-public offerings to CPIAs.i. ISSUE §4(2) is limited to “issuers” but makes no reference to CPIAs. Under §2(a)(11), CPIAs are treated

as “issuers”; created an inconsistency. So SEC created 4(1)(1/2) to bridge gap and extend §4(2) to CPIAs.1. B/c CPIAs are NOT issuers for purposes of 506 or REG D offering safe harbors.2. Ex. Bill gates sells to sophisticated investor he needs to provide disclosure but not comply w/section 5 but

if Microsoft sells to sophisticated investor it is a 4(2)--- Bill cannot use Reg D (506) b/c it it only available for issuers

ii. §4(1)(1/2) allows control persons to do a §4(2) NON-PUBLIC offering if the Ralston Purina standard for sellers for non-public offerings are met:

1. Must be sold to sophisticated investors (w/in meaning of Ralston) who either: a. Have access to issuer info by virtue of their position w/in the company; ORb. Have received some form of fair & accurate disclosure.c. B/c CPIAs are NOT issuers for purposes of 506 or REG D offering safe harbors.

2. NO general solicitation (so not public) iii. Tacking for Rule 144 goes back to original date of issuance NOT the §4(1)(1/2) resale date.

c. RULE 144 EXEMPTION safe harbor from §2(a)(11) designation of UW; persons meeting criteria are NOT engaged in a distribution & NOT UWs (meaning they do NOT have to perform a §5 registration & disclosure).i. Overview: “Persons deemed not to be engaged in distribution & therefore not UW” w/in the meaning

for 2(a)(11) for the purpose of 4(1)1. §4(1) + §5+ §2(a)11) CPIA & holders of restricted securities may not sell their securities in the public

market w/o registering their offers or find an exemption2. Rule 144 double duty: 2 classes that do not need to register- 1. Holders of restricted securities + 2.

Control people/affiliatesa. 4(2) Safe harbor by which affiliates (CPIAs) may sell ALL securities to the public w/o §5 registration.

i. In sell of ANY securities under Rule 144, must file Form 144 IF, during 3 month span, sell MORE than 5,000 shares or $50,000 aggregate mere reporting form, NOT disclosure

b. 3(b) exempted exercise: Safe harbor letting ANYONE (holders of RS) sell restricted securities to the public w/o registration.

i. “Restricted Securities” – those acquired from issuer or CPIA of the issuer in a transaction NOT involving any public offering securities issued using §4(2), Reg D, or Reg S, Rule 144- not yet in the hands of the public

1. 506 or 4(2): need to hold for 6 months if you want to do a 1443. Basically made-up test to prove that you’re NOT an UW & intent at purchase was investment.- deemed

not to be engaged in distribution of securities & 4(1) will not apply to them a. For CPIAs, even more important b/c their restrictions NEVER go away due to §2(a)(11)

ii. 4 Types of Transactions under Rule 144 HOLDING PERIODS1. Restricted Securities of REPORTING Issuer (PUBLIC company)

a. Non-Affiliate MUST have been a non-affiliate for at least 3 monthsi. First 6 months – CANNOT resell, no matter what.

ii. B/w 6 months and 1 year – can sell to anyone IF the issuer is current in its public reporting requirements (all its ’34 act fillings)

iii. After 1 year – securities aren’t “restricted” so have NO limits! - no 144 restrictionsiv. Note: not all securities traded on stock exchange were registered under section 5.

b. Control Persons/Affiliate (CPIA) i. Time Frame

1. Non-restricted securities (e.g.: from NASDAQ, NYSE) – NO time limitations!2. Restricted Securities (4(2), reg D or reg S—NOT reg A) – wait 6 months.

ii. Rule 144 requirements which MUST be met: 1. ***Current public information (’34 Act filings) 2. Volume limitations – every 3 months, can sell no more than 1% of outstanding or

average weekly volume of the previous 4 weeks3. Equity securities/common stock – can only be sold via regular broker transactions on

open market anonymous and CANNOT do private sale while using Rule 144- cannot negotiate the price

4. Debt securities – NO limitations as to where they’re soldiii. No Requirement for disclosureiv. Ex. Bill gats buys Microsoft securities on NASDAQ he cannot sell the next day b/c I do not

know if I bought from him as an underwriter.2. Restricted Securities of NON-REPORTING Issuer (PRIVATE company- securities not traded on public

stock exchange)a. Non-Affiliate MUST have been a non-affiliate for at least 3 months.

i. First Year – NO sales permitted. ii. After 1 year – securities aren’t “restricted” so have NO limits!

b. Affiliate (CPIAs) i. Time Frames

1. Non-restricted securities (e.g.: from NASDAQ, NYSE) – NO time limitations!2. Restricted Securities – MUST wait 1 year.

ii. Rule 144 requirements which MUST be met: 1. ***Current 15c2-11 disclosure info available to public2. Volume limitations – every 3 months, can sell no more than 1% of outstanding or

average weekly volume of the previous 4 weeks3. Equity securities – can only be sold via regular broker transactions on open market

anonymous and CANNOT do private sale while using Rule 144. 4. Debt securities – NO limitations as to where they’re sold.

3. ANALYSIS – if “restricted securities”, first ask who owns it: a. If regular person – ask for how long and see if restrictions are lifted. b. If CPIA – restrictions are never lifted; have holding period and then have Rule 144 requirements

4. EXAMPLE: If he got the shares in intrastate offering. Are the shares restricted? If affiliate- he cannot sell; if non affiliate- 3a11 and 147 are its own work (exempt transaction by itself) so needs to hold for 9

months then can selld. RULE 144A exemption from UW status under 2(a)(11) in the private resale of securities to institutions.

i. Allows qualified institutional buyers (QIBs) who buy REG D securities to sell to other QIBs w/o being deemed underwriters and, therefore, w/o having §5 registration requirements.

1. “Qualified Institutional Buyers” – an institution with more than $100M in assets.2. 2 Limitations

a. ONLY involves class of securities NOT otherwise available in the public market. (CANNOT have been already traded)

i. HYPO: If obtain Microsoft common stock in §506 offering – CANNOT use this exemption.; some preferred stock only available to QIB may be exempt

b. Issuer must make certain information available to any QIB who asks for it.3. PERMITS general solicitation (contrary to Ralston Purina). 4. Creates an aftermarket in restricted securities for QIBs can purchase w/intent to distribute w/o being

an underwriter as per §2(a)(11), which normally is illegal.a. Also permitted b/c §2(a)(11) covers view to distribute to the public, BUT QIBs are private. (Theory

that we do not need to regulate these huge institutions in trading securities)5. HYPO: GE pension buys Microsoft Preferred B thru 506 and next day sells it to AIG not underwriter6. HYPO: Insurance company is QIB & owns $100M securities- can sell the next day to pension fund and

not be an underwriter. RECAPITALIZATIONS, REORGANIZATIONS & ACQUISITIONS1. §3(a)(9) Exempt Transactions (Exchange offers)

a. “Exempts from §5 any security exchanged by the issuer w/its existing security SH exclusively where no commission or other renumeration is paid or given directly or indirectly for soliciting such exchange”

i. Drafting error: says “securities” but really are transactions that need no registration/disclosureb. Statutes:

i. §5: every sale or offer to sell securities must be registeredii. §2(a)(3): the term “sale” shall include every k of sale or disposition of security... for value

c. Sell FOR VALUE or DISPOSITION FOR VALUE: 2 conditions where value exists:i. Recipient of a security (investor) makes an investment decision; OR

ii. If no investment decision, transferor must have some benefit conferred to them1. Tangible or intangible benefit but NOT IRS deductions or “good feelings”

a. HYPO: Gates gifts $1MN in stocks to Harvard or his son-does NOT need to register, b/c Harvard made no investment decision & no value was received by Gates (but may be benefit conferred if they are getting the son into law school)

2. Free Stock : can create instant aftermarket is a benefit a. EXAMPLE – Dot.com gave away 1B shares for free to any website visitors in attempt

to create instant aftermarket for its securities w/o a §5 registration. HELD illegal by SEC b/c the aftermarket was a benefit to the company and to insiders who could then start selling their shares via Rule 144 in this market.

d. Stock Dividends : Disposition but NOT for value NO investment decision & company receives no benefiti. SEC View: choice b/w cash or stock dividend does NOT involve sale/offer even though recipient

is making an investment decision1. BUT request by buyer to change dividend rate IS an investment decision2. HYPO: Debenture for 12%, so reduce the dividend to 2% and if you don’t we will go poor

but if you do you are getting something less than you are entitled to needs to be registered b/c making investor make investment decision between 12% and go bankrupt or 2% and help the company

ii. Dividend reinvestment plan: Where SH, by prior K, has their dividend applied to purchase of more securities at market price IS for value b/c it is a continuous offering BUT exception & does NOT need to be registered

e. Warrants & Convertible Securities – must you register both the initial issuance of warrant/convertible security and the security into which it is converted? Is the underlying security for value under §2a3?

i. IMMEDIATELY Exercisable/Convertible : SEC says that two separate securities are being offered so BOTH must be registered absent an exemption (or the registration statement must cover both securities).

ii. NOT IMMEDIATELY Exercisable/Convertible – SEC says that the underlying stock does NOT need to be registered at the time of the offering of the warrant or convertible security.

1. When it becomes exercisable/convertible, there MUST be a §5 registration or exemption in place covering the underlying stock b/c SH is making an investment decision daily to exercise/convert (or not).

a. HOW keep prospectus open for whole duration of option via amendments & keeping everything updated so there’s an effective registration statement available for the entire conversion period

b. Ex. Convertible bond: 10k, 10%, due 2030 convert to 1k shares of common stock in 5 years. In year 5, you are asking the investor to make investment decision by asking them to convert or hold the bond- needs to be registered.

iii. AUTOMATIC Conversion – does NOT need a new registration statement for the underlying security b/c the investment decision was made when the original convertible security was bought.

f. Bonds – ANY vote to materially change a bond (even if unsuccessful) constitutes an investment decision & therefore a new security is being offered (and must be registered).

i. “Material Change” – modifies such that a reasonable investor would think it’s a new security. g. Spinoffs – corporation takes smaller sections of their company and spins them off into separate companies

with their own stocks, which are issued pro rata to parent SHs via a stock dividend. i. Spinoff is NOT for value b/c there’s no investment decision (subsidiary shares just showed up) and no

value to the issuer (receives no distinct advantage relative to others b/c disseminated pro rata) but now there is a market for the subsidiary shares, w/the same results as a disguised IPO, w/o registration.

ii. RESULT – regulated through ’34 Act where no broker can trade stock unless there’s adequate registration/disclosure in the market

iii. EX: Company X owns pet, pharma, etc. Board no longer wants pet company and asks for buyers. It does a spin off and has 1k SH each w/1k shares (1M shares outstanding). They mail out shares of pet company to SH Not for value b/c they are not in a different economic position- the investor basket of ownership is the same before and after and they are just getting what they own, so no benefit

2. 3(a)(9)EXCHANGE OFFERS safe harbor: offer to exchange some common shares for preferred ones (or vice versa) is exempt from §5 Registration

a. Double Exclusivity Test: an offer to exchange securities by the issuer is exempt if it is:i. Exclusive to existing Shareholders : no security offering to anyone other than existing SH for 6 moths

after §3(a)(9) exchange occurs1. Integration : problem w/exclusivity arises if issuer is doing another simultaneous offering to

non-SH b/c the offers are integrated & exemption is lost2. Examples:

a. If I am doing a 3(a)(9) and I have debenture holders and I am offering them 10 of shares of preferred stock for every $1000 debenture. I send them 10 shares for every $1000 debenture I receive and there is no problem. This offer of common stock need not be registered.

b. Same facts as above, but I’m doing a simultaneous RULE 506 offering for preferred stock. The SEC will say that I’m offering preferred stock not exclusively at this particular time to my debenture holders under 3(a)(9) and offering preferred stock to outside investors under RULE 506 and I have violated the exclusivity requirement.

c. If do §3(a)(9) and offer 10 shares common stock for every 1,000 debenture, but then does a §506 offering, then exclusivity is breached and there’s NO exemption

ii. Exclusively Security for Security : NO actual consideration ($$) can be exchanged1. Issuer CANNOT pay for legal or tax advice for the SH in connection w/the exchange2. NO sales commission can be paid in connection w/the exchange3. EX. – can’t offer 10 shares common stock plus $10 in exchange for 1,000 debenture b/c

additional consideration NOT exempt under §3(a)(9) & must register under §5.b. Good Faith Requirement: SEC reads in good faith business purpose for the transaction

i. Examples: pg. 4141. Company offers tax advice to help it’s existing security holders who take other securities

instead. This violates 3a9 since it is extra remuneration.

2. Company wants to do an exchange offer as well as a registered offering. If the security they are offering to the new investors is the same as that they are offering in the 3a9, it will be integrated and you will blow the 3a9 exemption.

c. Character of Exchanged Securities: Must be the SAME as the one given upi. Resale of 3(a)(9) Securities: Exchanging security hold must find own exemption for sale

ii. Tacking: generally available to assist holder in meeting period (1 year for Rule 144)3. EXEMPT SECURITIES

a. Intro – nature of the security itself, rather than the manner of the transaction, makes these securities exempt they pass the howey test also

i. §3 ALSO has exempt TRANSACTIONS (§3(a)(9), §3(a)(11), §3(b) (Rules 504, 505, Reg A)); but the rest of §3(a) covers exempt securities.

b. §3(a)(2) (Government Securities (“Muni Bonds”)) – securities issued/guaranteed by gov’t are exempt MUST be granted tax exempt status from IRS

i. PURPOSE – gov’t bonds are given §5 AND tax exemption b/c they are socially valuable projects that we want to have preference relative to corporate ventures.

ii. To be exempt from Section 5: IRS grants tax exempt treatment + disclosure documentiii. 2 Types of “Muni Bonds”:

1. General Obligation Bonds (GO) – backed by the full faith and credit (and taxing power) of the issuing government entity; can be issued by federal, state and local governments. (ex. State pledged tax revenue to repay the bonds) ALL EXEMPT

2. Industrial Development Bonds (IDB) – bonds issued by gov’t to raise money for public works projects and are backed by revenue of the project (i.e.: sewers, dams, highways).

a. HOWEVER, not every bond issued by gov’t authorities is tax exempt. IRS has a VERY detailed list of what qualifies, usually limited to socially valuable projects (e.g: sports stadiums are not exempt).

b. Tax exemption is used to promote these projects and allow them to raise money at a lower interest rate generally equal to the IR of corporate bonds (minus) the marginal tax rate. (interest on the bonds must be TAX FREE)

c. HYPO: GE wants to sell you a $1K, 10 yr corporate bond @ 10%. Of the $100 earned, you have to pay 30% in taxes and you get a $70 take-home return.

d. HYPO: NYC offers $1K, 10 yr corporate bond @ 7%. Of the $70 earned, you get to keep ALL of it b/c it is tax exempt.

e. NO full faith and credit of US – and $$ coming in may not be enough – so there are default risks.

iv. Bank Securities – exempts any security issued/guaranteed by a bank, including foreign banks w/US branches (ex. Citi bank is exempt but not citi group)—they are supervised by federal or state government (better regulatory authority exception to Howey test)

v. Trust Funds & Pension Plans – interests in trust funds maintained by banks are EXEMPT; banks must have “substantial investment responsibility and these CANNOT be used for general investment by the public”

c. §3(a)(3) (Commercial Paper) – notes used by large companies to borrow for short terms to cover debts.- “note, draft, bill of exchange, or bankers acceptance” securities are exempt

i. General1. EXAMPLE – GE has $100M in cash so puts in Bank, Microsoft needs $100M for next days

payroll so it borrows and then, a few days later, Microsoft gets earnings and pays off bank).2. NOTHING to do w/commercial notes & Reves (which have maturity for 1 year & are used by

citizens).ii. REQUIREMENTS:

1. Current Transaction – proceeds must be used to fund current transactions- “assets easily convertible into cash and comparable to liquid inventories of an industrial or mercantile company”

2. 9 Month Maturity – can’t have a maturity that exceeds 9 months (270 days); automatic rollovers are a problem.

3. Prime Quality – Debt must have the highest short term rating (AAA) by recognized rating agencies.

4. Manner of Offering – limited to securities “not ordinarily purchased by general public” – ENFORCED by requiring it to only be issued in large amounts, prohibiting general solicitation, & requiring sophistication.

d. §3(a)(4) (Non-Profit Issuers) – securities issued by religious, educational, benevolent, fraternal, charitable, or reformatory organizations and NOT for pecuniary profit/benefit of SHs are EXEMPT from §5 requirement.

e. §3(a)(5) (Highly Regulated Industries) – securities issued by a savings & loan associations, banks, building & loan associations, or coops, are EXEMPT b/c they’re industries regulated by state/federal authorities (own regulatory system)

f. §3(a)(6) (Railroads) – railroad securities EXEMPT b/c lobby was VERY powerful in 1930s g. §3(a)(7) (Bankruptcies) – securities issued pursuant to bankruptcy reorganization plans approved by court

orders are EXEMPT rationale is that the bankruptcy code protects this.h. §3(a)(8) (Insurance Policies) – EXEMPT b/c industry is already heavily regulated. i. §3(a)(11) Intrastate- See abovej. §3(a)(12) (Bank Holding Companies) – shares issued by a bank holding company are EXEMPT.k. §3(a)(13) Better Regulatory Authority

i. Examples: pg. 414:1. Sample exam question company needed money to pay off debentures. Instead of raising

506 do an exchange offer – benefit in doing this, get rid of debentures, no registration, can do general solicitation, etc.

2. Venture sales SH don’t want to be involved in company anymore, so company will take back common stock and give preferred stock. Mentioning of accredited/non-accredited doesn’t have anything to do with this. 3(a)(9) says if they are SH can make exchange. It is irrelevant whether they are sophisticated or accredited.

LIABILITY UNDER THE ’33 ACT1. Prior to ’33 Act : only relief for securities fraud from CL tort of fraud- required plead & proving:

a. Misstatement or Fraudb. Scienter (intent to commit fraud)c. Causation (misstatement caused the loss)d. Privity (P is in direct privity w/D- no fraud through hearsay)e. Reliance (reliance on the misstatement to your detriment)f. Damages (difference value represented and actual value)

2. § 11 False Registration Statement Civil liability for MATERIAL MISSTATEMENTS in RSa. §11(a): in case any part of the registration statement, when such party became effective, contained ANY

untrue statement of material fact of an omission of material info, then investors can suei. Requirements: material misstatement + privity + damages

1. Misstatement: any untrue statement of MATERIAL fact or omission of material info2. Privity: established via daisy chain method if you can trace back privity through a line of

people who, initially received it via a RS containing a fraudulent misstatementa. “any person acquiring such security can sue”- do not need to read prospectusb. EXCEPTION: investors cannot succeed if it is proven that they knew about the

material misstatements at the time of acquisition (he knew the truth)c. EXAMPLE: if 97% of outstanding securities were sold via faulty registration

statement, P can’t just do statistical analysis and assume his were faulty must trace the security.

d. Ex. Daisy chain privity: A bought in and sold those exact same shares to B who sold the same shares to C, then to D, then D can sue

i. If A sold to B at 12, B sold to C at 14, and C sold to D at 20 (and difference from misstatement was 8) D can only sue for 8: this is a natural cap on damages

ii. Versus CL: Do NOT need to show: causation, scienter (can be honest mistake), relianceb. Limitations

i. Only available for §5 Registered Public Offerings NOT exempted/restricted securities (3(a)(11), 3(a)(9), 4(2), 3(b), Reg D)

ii. Only for statements made in the effective registration statement NOT available for statements made in preliminary prospectus (“when such part became effective”)

iii. Statute of Limitations: 3 years after fraud was discovered & 5 years after fraud took placec. Who can be sued? The following can be sued personally: §11(a)

i. Issuer: has no defensesii. Every Person who SIGNED the RS Issuer, President, CEO, CFO, Directors, Comptrollers

iii. Directors/Partners of Issuer (at the time of filing, even if they did not sign it- for entire RSiv. Imminent Directors of the Issuer: every person who, w/his consent, is named in the RS as being or

about to being director/partner/etc, even if they did not signv. Experts named in the RS: as having prepared or certified any part of the RS (accountants, engineers,

appraisers)- with their consent were named in the RS1. Experts are only personally liable for the portion of the RS attributed to him & NOT the rest

of the RS2. Lawyers: not considered experts unless they issue a report on a legal issue

vi. Underwriters: ANY (commercial & statutory) UW involved in the distribution of the security1. Heightens scrutiny: forces UW to take an interest in what they are doing BUT do not want

UW to be personal guarantors of the issuer (do not want to dissuade them) which is why we have §11(b) defenses

2. Only liable for the amount of shares they sold must have done everything they could to investigate the company’s info as accurate

d. DEFENSES- Escaping Liability- Due Diligence Defense- §11(b): no person, other than the issuer, shall be liable who, after reasonable investigation, had reasonable grounds to believe (and did believe) that the registration statement did not contain a material misstatement

i. Issuer: per se liability no matter what strict liability for material misstatement or omissionii. Document Due diligence: show you did EVERYTHING you could to ensure the RS was not false-

reports, interviews, create files of what has been coneiii. Due Diligence Standard: §11(c): standard of reasonableness is that required of a prudent man in the

management of his property1. Experts: held to the industry standard of a reasonable person in their profession

(OBJECTIVE)a. Ask: Could they have done anything more? If not, they are safe

2. Reliance on Experts: Directors (NOT ISSUERS) can rely on experts information and do nt need to do any due diligence must hire a reputable expert & are “entitled to rely on the expert’s section”

a. NOT valid due diligence defense to claim they relied on lawyers3. Others: Sliding Scale SUBJECTIVE Test What a prudent person w/that knowledge &

abilities would have done in those circumstancesa. Escott v. BarChris: standard of care is not applied uniformly. Look at each D and ask

“what reasonably care would I expect from that person” based upon their position, expertise, & function in the company?

i. Outside Directors: need to make reasonable investigation to the best of their capabilities given their knowledge and experience in the industry

b. Ex: plastics co has to directors and they are preparing the prospectus, one is a college chemistry professor and the other is a travel agent. Both will have to ask questions and investigate, but more is expected of the professor, he has to visit the plant and ask questions to the experts that the travel agent didn’t know about.

c. Ex: 2 directors (chief marketing officer and chief production officer). Reg statement has a misstatement that the distribution network is tied up in a 5yr K and this is wrong. Issuer has no defense. CPO asks CMO, his assistant and distributor. This is probably enough to maintain a due diligence defense. CMO had to know, he wrote the Ks. Even if he just started and didn’t know, he loses because it was his business to know and he had a higher standard. It’s a sliding scale.

iv. Rule 176: SLIDING SCALE STANDARD for DUE DILIGENCE:1. Circumstances affecting the determination of what constitutes reasonable investigation &

reasonable grounds for belief under §11:

a. Look at persons position & his ability to ferret out informationb. The type of issuer (does the person have expertise in that area?)c. The type of securityd. The type of persone. The office held when the person is in officef. The presence or absence of another relationship to the issuer when the person is

director or proposed directorg. Reasonable reliance on officers, employees, and others whose duties should have

given them knowledge of the particular facts (in light of the functions & responsibilities of the particular person w/r/t the issuer and filing)

h. When the person is an underwriter, the type of underwriting arrangement, the role of the person as an UW and the availability of info w/r/t the registration

i. Whether w/r/t a fact or document incorporated by reference, the person had any responsibility for the fact at the time of the filing from which it was incorporated

v. NEGATIVE CAUSATION DEFENSE: D may be able to show the decline is for reasons other than the misstatement

vi. Whistleblower Defense: Director can escape liability if prior to effective date of the part of registration to which his liability is asserted her (1) resigned & (2) advised SE & issuer in writing that he had taken such action and would not be responsible for that part of the RS

e. DAMAGES under § 11 Recissionary b/c no intent requirementi. §11(e): Calculation: Damages per share are calculated as equal to the difference between (1) the

amount paid for the security (NOT exceeding offer price to the public) AND (2) value of the stock when the suit was brought or the price at pre-suit sale or the price after-suit but pre-judgment IF price went up

ii. §11(g): Upper Limit: Amount recoverable CANNOT exceed price of security when offered to public (not the price you paid)

1. Ex. Stock offered at $10, peaked to $80 when P bought, then fell to $9. Max is $1 per share. If it fell to $11, then no recovery

2. Upper limit for issuer: amount the issuer sold it for3. Upper limit for UW: Amount the UW bought and sold for

iii. §11(e): Negative Causation: If D proves that any portion of the damages represents factors OTHER than depreciation was the misstatement, then that is reduced from the ultimate loss calculation

1. Does not introduce causation requirement, but an element of defense for D2. Ex. Stock offered at $10, not at $1; If D proves the entire market went down %30, D is only

liable for $6 which is attributable to the misstatement (would have been $7-1)iv. §11(f): Joint & Several Liability: any judgment rendered against a group of individuals is fully

enforceable, in any amount, against each of them. P can choose who pays how much.1. EXCEPTIONS:

a. Outside directors (director not employed by the issuer) may plead “proportional liability” & reduce their share of damages to the amount of harm they actually caused so liability in the absence of knowing misconduct is proportionate

b. Underwriter Liability ; may NOT exceed the total price that the securities written by him and distributed to the public were offered to public (but w/J&S can get 100% liability)

v. Indemnification: Issuers CANNOT indemnify any person liable under §11 (against public policy) but the issuer CAN purchase insurance for directors

vi. Change in the Burden of Proof (2006): If the issuer publishes generally, earning statements, covering a 12 month period after registration statement, the burden of proof changes and the investor must show he relied on the misstatement. Reliance on the issuer, when there is this publication.

1. the Δ can prove that any portion of the decline is from something other than the material misstatement

a. Pleading issues: Causation doesn’t have to be pled or proven. The Δ, after he is found liable, may reduce the amount of damages by proving that there was another cause

b. Ex: diminution in value based on other extraneous circumstances

3. §12: Civil Liability of Non-Registered Offerings for any person who offer/sell securities in violation of §5a. §12 Direct Privity Required: Only direct purchaser may sue the issuer/UW/dealer (and those who show the

stock they bought was attached to the violation)b. §12(a)(1): Failure to Register: offers/sells of security in violation of §5 (exemption not available and failed

to register) is liable to the person purchasing that security from him to recover the consideration paid (rescission) for such security w/interest, less the amount of any income received

i. Direct Privity : only investors purchasing directly from issuer/UW/Dealer can sue (unless they used an exemption)

ii. Strict Liability : no scienter, causation, or due diligence defenseiii. Damages :

1. If still own security get price paid in original transaction + interest (minus income received)

2. If sold security get difference b/w price paid & lower price in sale (minus income received) rescission (put P in position as if transaction never happened)

iv. Examples: gun jumping; failed Reg D offerings; failed 4(2) exemption- if engaged in general solicitation; failed 3(a)(9) exchange offer; failed 3(a)(11) intrastate offering

c. §12(a)(2): Misstatement in Prospectus or Oral Communication: any person who sells a security by means of a false or misleading (untrue statement of material fact or omitted a material fact) prospectus or oral communications AND the buyer did not know of the misstatement (buyer has burden of proof) shall be liable to the person purchasing the security for the consideration paid (rescission) for such security

i. Due Diligence Defense : unlike §11 and 12(a)(1), Issuer and anyone who offers/sells a security has a due diligence defense

ii. Statute of Limitations : no more than 3 yrs after fraud was discovered & 5 yrs after fraud occurrediii. Meaning of “Prospectus ”: §12(a)(2) limited to registered offerings

1. Gustafson v. Alloyd (SCOTUS GOT IT WRONG): b/c term prospectus only appears in the context of a registration statement, §12(a)(2) is available only for registered offerings and there is no liability for fraudulent disclosure documents other than prospectus in a registered offering

2. JALIL’s TAKE: §12(a)(2) NEVER mentions registration statements- only says prospectus, so it seems that §11 should be for registered offerings w/faulty RS and §12 for unregistered offerings w/bad communications/prospectus

a. BUT we have to follow majority if buyer sues under §11, no due diligence defense, but if brought under §12(a)(2) then DD defense for issuer

b. Should be: (JALIL)i. §11: registered offerings= more time/care taken in process- no DDD

ii. §12: non-registered offerings= docs prepared in 4(2), 505 for memos3. So there is NO SECTION of ’33 Act where liability exists for Non-registered (non-public)

offerings (reg a, reg a, 4(2), 5050, 506)iv. §12(b) Loss Causation: if any person proves there was a depreciation of value for reasons other than

bad communications/prospectus, you only get a diminution valuev. Remedy/Damages : as long as you prove the offering document was materially misleading + issuer

was not duly diligenced. §14: NO WAIVER: cannot waive any condition, stipulation or provision binding any person acquiring a

security to waive compliance w/the rights under the ’33 Acte. §15: CONTROL PERSON LIABILITY: any person who controls a corporation liable under §11 or §12

(and §17) is also liable J&S with and to the same extent as them have a due diligence defensei. Purpose: prevents people from hiding behind straw persons and becoming judgment proof

f. §17: FRAUDULENT INTERSTATE TRANSACTIONS: Unlawful (jail) to use any instruments of interstate commerce or mails, directly or indirectly, to:

i. Employ any device, scheme or artifice to defraud,ii. To obtain $$/property via an untrue statement or omission of material fact

iii. To engage in any effort which does/would operate as a fraud or deceit of the purchaseriv. Note: §17 does NOT offer a private right of action ONLY Sec can use to penalize brokers/firms

SECURITIES EXCHANGE ACT OF 1934

1. Intro : Consumer protection regulatory statute having to do w/secondary transactions & creation of the SEC2. §2: Necessary for Regulation: “transactions in securities as commonly conducted upon securities exchanges & OTC

markets are affected w/a national public interest which makes it necessary to provide for regulation & control of such transactions & of matters related thereto”

a. Lays out basis for expanse power in ’34 Act & creation of SEC3. §4: Creation of SEC: It is hereby establish, a securities & exchange commission (SEC) composed of 5

commissioners (w/5 year terms), appointed by president w/advice and consent of Senatea. Non-Political : No more than 3 from 1 political party (if D pres & 3 Ds, must appoint R)

4. §5: Exchanges must be registered w/the SEC or Exempted (power to register= power to regulate)5. §6: Illegal to trade on exchange that is not registered w/the SEC: national sec. exchange must be registered6. §7: Margin Regulation: Federal Reserve Bank Regulation only § of securities law not regulated by SEC

(regulated by Fed Reserve Bank) min. equity requirement at 50% (can’t borrow >%50 of value of the stock)a. Purpose: keeps people from buying stock who don’t have equity interest in that stock

i. Highly leveraged market= inherently unstable market (if too big, market could collapse)b. Margin Trading : borrowing $ from brokerage firms to conduct greater trading on the market w/less equity

(Margin= the money you borrowed) (Leverage your investment= making greater return than you would have)i. Margin Call: When broker asks for more equity b/c below the margin

ii. HYPO – Want to buy 1000 shares @ $1/share but only have $100 – ask broker for loan of $900; Broker’s ok w/ it b/c loan is secured – has the shares and if you don’t pay, he can just sell the shares.

1. Stock goes to $2 – can sell stock to get your $100 dollars, pay back the $900 to the broker, and get $1000 in profit leverage can dramatically increase earnings.

2. Stock goes down to $0.70 – now 1000 shares only worth $700, so broker is out $200 if you skip town & he sells your entire position (you’re out your initial $100 of equity)- panic selling

7. §9: Market Manipulation: no person can use for the purpose of creating false/misleading appearance of active trading any security or the market, resulting in no change in the beneficial ownership criminal liability

a. No “wash sales” : 2 parties/brokers trade a thinly traded security back & forth to drive up price, inducing other investors to join, and then get out at high price and let stock fall b/c nothing supported the rise

b. Purpose: retain confidence in mom/pop America- need to know the price is fair market value (willing buyer would buy and willing seller would sell at arms length transaction)

8. §12: Requirements of Public Companies: traded on exchange (reporting company) (like §5 of ’33 Act)a. §12(a): ’34 Act Registration: can’t transact any security (unless exempted) on national securities exchange

unless a registration for that security is effective for such exchange must comply w/disclosure requirements of ’34 Act if registered a class under §12b

i. Under ’33 Act, we register the offering; Under ’34 Act, we register the securitiesii. Must register the entire class of securities

iii. All reporting companies are public companies but not all public companies are reporting companiesb. §12(g): MANDATORY Registration: if issuer has assets of $10M AND 500+ SH in a given class, it must

register that class of stock under §12 (file Form 10) regardless if stock is traded (publicly)i. §12(b) Voluntary Registration: if you do not meet §12(g) + still want to be publically traded

ii. Ex. MasterCard common stock is not traded, but still needs to registeriii. If issuer filed §5 RS, pretend it’s a reporting company for rest of the yr the registration was effective

c. Effect of Registration : Once a security is registered: Security can be publicly traded: entire class is registered, even ones that don’t trade

d. Reporting requirements : MUST make info publicly available via EDGAR- disclosures of §13(a):i. Must file 8-K anytime something happens- monthly & certain things like mergers

ii. 10-Q: quarterly filings (unaudited financial info, managements opinion about the inf)iii. 10-K: yearly filing (large, detailed disclosure doc w/audited financials- similar to ’33 RS)

9. §13(d): Transaction Disclosure: Anyone owning >5% of §12 registered stock MUST file Form 13D w/in 10 days of acquisition w/SEC (and inform issuer/exchange of trading)

a. Must disclose on form:i. Identity of purchaser or group

ii. Source of funds used to buy securitiesiii. Where did you buy the securities?iv. What you intend to do w/the shares (hold as investment, hostile takeover)

b. Must amend Form 13D for every 1% change in ownership (to track creeping acquisitions)10. §14: Proxy Statements & Tender Offers

a. §14(a): Proxy: unlawful for any person, in contravention of SEC rules, to solicit any proxy, consent or authorization in respect of any security (other than exempted) registered pursuant to §12

i. Anyone who solicits proxies from SH MUST send a proxy statement (disclosure statement giving info about what it to be voted on)

b. §14(d): Tender Offer (Williams Act): making a tender offer for certain % (all or most) of outstanding shares of a company from the market must file form w/SEC to disclose your actions & intent BEFORE tender offer & you must pay all SH the same price, regardless of what they tendered, & remain open for a certain amount of time

i. Disclosure : What are the intentions? How much do you want? What price are you going to pay? Where are you getting the financing?

ii. Intention is question of fact: If start buying b/c not sure & file 13D, but decide to do a tender offer after already owning 25%, it is probably bad

11. §15: Broker-Dealers: All brokers & dealers must be registered/licensed w/SEC & FINRA to trade/offer securities & need sufficient capitalization (or it is unlawful)

a. SEC delegated broker/dealer regulation to a Self Regulated Organization FINRA- administers & approves exams, issue membership (daily regulation- owned by broker/dealers) & passes to SEC for licensing (SEC does not have merit review authority)

b. Convicted felon cannot be a broker dealer for 10 years (but can have a hearing- SEC decides)12. §16: Directors, Officers, & Principal SH (SEC GAAP) ONLY Registered class under §12

a. §16(a): Every director, officer, 10%+ SH must report every sale/purchase of any §12 security w/in 48 hours & tell how much you bought, if you sold, and what price

i. Form 3: must be filed when you first meet these criteria (director, officer status)ii. Form 4: must be filed w/in 48 hours of every purchase/sale

iii. Form 5: annual summary formiv. Purpose: Fiduciary obligation to SH who have a right to know what employees do w/stock

b. §16(b): Short Swing Profits Rule: as to reporting company, any reporting officer, director or 10% SH who buys & sells a security w/in 6 months MUST disgorge any profit to the company

i. If issuer does not sue, then any SH can sue derivatively & recover attnys feesii. Strict Liability: no state of mind standard bright line rule (except: stock option plan))

iii. Converse is true: If I sell security & buy back at lower price, the profit belongs to company iv. Recovery: look at highest price compared to lowest- disgorge most amount of profit

Note: Jobs (Jump start our business startups) Act: Crowd funding (sale of small amounts of stock to many individuals- like public offerings) versus institutional funding

INSIDER TRADING & FRAUD §10b1. §10b: unlawful to use or employ, in connection w/the purchase/sale of ANY security (both registered & unregistered)

any manipulative or deceptive device in contravention of rules/regulations as SEC may prescribea. NOT self-executing: allows SEC to make a ruleb. Private Securities Litigation Reform Act (1996): need to plead w/specificity which statement was misleading

2. RULE 10b-5: Employment of Manipulative or Deceptive Devices (PRIVATE RIGHT OF ACTION)a. Two part test:

i. Unlawful for any person, directly or indirectly, to:1. Employ any device, scheme, or artifice to defraud, OR2. Make any material untrue statement or omit material info needed to make it not

misleading, OR3. Engage in any act, practice, or course of business that operates as fraud/deceit upon any

personii. In connection w/the purchase or sale of ANY security eliminates privity, adds causation & liability

it is if reasonably foreseeable people would trade on the fraudulent info1. SEC v. Texas Gulf: D mined & rumors that D made huge mineral find. Ds execs denied

rumors, but were lying & it was eventually discovered.

a. Rule 10b-5 is violated whenever assertions (false, misleading or incomplete) are made in a manner reasonably calculated to influence the public

b. D did not sell any securities did not matter b/c offending party need not trade, as long as someone did based on the misstatement

b. 10b-5 Standing : private right of action for ANYONE who purchases or sells securities in RELIANCE of the information only those who actually bought or sold; mere loss of value is not enough if you did not sell

i. No privity : Need not have to purchase from the misfeasorii. EXCEPTION: aborted seller doctrine: Someone is about to sell/buy, all intentions to do so, but

deception came and prevented it from happening (hard to prove)iii. No Standing: Frustrated buyers (I would have bought/sold but for the misstatement) & frustrated

sellers (held stock & did not sell during misstatement)c. Necessary Elements of 10b-5 : Standing (actual purchase/sale of stock) AND

i. Material Misstatement/Omission: requiredii. Scienter: person intended to defraud in sale of security w/knowledge it was false (also recklessness,

gross negligence, or willful neglect- not simple negligence) cannot just be a mistakeiii. Reliance: on the misstatement/omission must be proven

1. Fraud on the Market Theory (Basic v. Levinson): Need NOT prove reliance for each individual investor; just that the entire market relied on the misstatement (t/f investor did)

iv. Causation: must prove damages are rooted in reliance on misstatement in buy/sell & reliance was reasonably foreseeable

v. Damages: required & UNLIMITED b/c in connection w/any purchase/sale (no privity)1. Loss Causation : D can mitigate damages by proving entire market went down the day of the

misstatement only recover difference due to misstatementvi. NO Privity: can be market reliance on actions- does not need specific investor reliance on it

3. INSIDER TRADING: trading on the basis of MATERIAL, NON-PUBLIC infoa. Intro: No insider trading statute (16b has nothing to do w/it) SEC uses 10b-5 (judicial interpretation)

i. Rationale: Want to keep consumer confidence capital markets would stall b/c people would think the markets are rigged against them and not a fair playing field so they won’t participate

ii. But Insider trading might be good: allows info to drive the price to reflect the true value of the security (even if the public doesn’t know why)

b. ESSAY ANSWER:i. Is the info non-public?

ii. Is the info material?iii. Assuming yes & yes, what position do you have w/the issuer? (Chiarella)

1. Rule 10b-5(1): Are you an insider or tempory insider of the company?2. Do you owe a fiduciary duty to SH of that company?3. Rule 10b-5(2): Was it a relationship of trust & confidence (employer, tradition, family)?

iv. Would you have traded anyway?1. But-for the info you traded?

a. Are you trading on the basis of the infob. Rule 10b-5(1): Safe harbor- Did you have a plan?c. Can show necessity of trading

v. How did you come upon this info?1. Insider - Fiduciary Duty

a. Dirks: from the issuerb. O’Hagen: form your employerc. Switzer/Electrician: accidentally overheard?d. Rule 14e3: Tender offer

2. Non-Insider : Misappropriationa. From an insider/tipper?

i. Was tipper given the info w/expectation of getting a benefit?ii. Was tippee aware of the source of the tip arose from a breach?

iii. Did tippee trade on the basis of the info?c. RULE FOR INSIDER TRADING: mere possession of material, non-public info is NOT itself a bar to

trade must be a breach of fiduciary duty (or 14e-3- cannot trade on mat, non-public info on tender offers)

i. Chiarella v. US: D was type-line operator and deduced the parties would be involved in takeover, based on spaces in doc, and took part in insider trading

1. HELD not guilty b/c there was NO fiduciary duty to issuer & D was not a temporary insider2. Overruled twice: but basis analysis remains (Rule 14e-3: tender offers & O’Hagan)

a. Rule 14e-3: Cannot trade on advance notice of tender offer- Fiduciary relationship DOES NOT matter (trading plan exception still applies)

d. WHO CAN BE LIABLE FOR INSIDER TRADING?i. Insiders : anyone who owes fiduciary duties cannot trade on material, non public info (Chiarella)

1. Directors, Officers, Employees: anyone employed by issuers has fiduciary obligation to their employer/issuer and FD to SHs

2. Temporary Insiders: lawyers, accountants, consultants, tax planners, clerical staff, bankers anyone told material, non-public info to fulfill their duties has FD like insiders

3. Ex. Joe finds CFO file on subway w/material non-public info- he can trade b/c no FDii. “On the Basis Of” : if an insider is NOT trading on the basis of such info, then trading is not barred

1. SEC v. Adler: President of corp sold stock just before bad news was released. He won b/c he didn’t sell b/c of the bad news, but for another reason (he would have sold anyway)

a. TEST: “but for” and/or “on the basis of” doctrine: i. But for the information he would not have traded (not guilty) OR

ii. He traded on the basis of such information (guilty)b. Burden on P (but 10b-5(1) reversed this burden)

2. Rule 10b-5(1): Codified Adler- Safe Harbor: trading presumed to have been on the basis of material, non public info if the insider was AWARE OF the non-public material info when making the purchase/sale Burden on D

a. AFFIRMATIVE DEFENSE: No liability under 10b-5(1) if BEFORE becoming aware of material info, D:

i. Entered into a binding K to purchase/sell the security, ORii. Instructed another person to purchase/sell the security for his account, OR

iii. Adopted a written plan for trading securities: MUST1. Specify the amount, price, and date the securities are to be purchased

or sold, OR2. Include a written formula, algorithm or computer program, for

determining the amount of securities bought/sold & price/date, OR3. NOT permit insider to exercise any subsequent influence on

timing/manner of sale/purchase of shares (NO deviation from plan)iv. Note: Rule 144- imposes volume limitations on trades by insidersv. 10b-5(1) puts together cases: Chiarella makes you liable if you have FD but

Adler gets you out if you can prove that its not but for the inside infoiii. NON-Insiders that may not trade on material, non public info:

1. MISAPPROPRIATION THEORY: party misappropriates confidential info for trading when they breach the fiduciary duty owed to the source of the info (not necessarily the issuer)

2. Rule 10b-5(2): Misappropriation TEST (non-exclusive definition- created in 2000) expanded definition of who has a “relationship in trust or confidence” under misappropriation theory beyond employer

a. Deception of source/breach of confidence (confidence between insider & other or based on relationship): (Based on source of info- not who was harmed)

i. Whenever a person agrees to maintain info in confidenceii. 2 people have a history, practice or pattern that recipient is expected to

remain in confidenceiii. Deals w/family relationships: spouse, parent, child, sibling (NOT cousin)iv. Defend : by showing no reasonable basis for knowing speaker expected

confidentiality baed on agreement or historyb. Consummated when traded upon, NOT when just acquired

i. Cannot ask for confidence AFTER the fact3. Background of Non-Insider Insider Trading:

a. SEC v. Carpenter: WSJ Editor had column “heard on the street” that moved the market. Lived w/broker and told her what he was going to say days before it was published

i. P won: D & broker stole info belonging to WSJ, who whom D held a FDii. If Dow Jones had traded on the info, would not have been 10b-5 violation

iii. If Goldman analyst digs and finds info, the analysy cannot trade on it either but Goldman can trade on it

b. US v. O’Hagan: D worked for law firm (but not directly involved in merger) & buys shares in companies involved in tender offer. HELD for P b/c D deceived law firms fiduciary trust in trading on insider info establish Misappropriation theory

i. JALIL: Does not like this case- lawyer would have been temporary insider & could have been liable under Chiarella

4. TIPPERS/TIPPEES: As long as tippee is not giving any benefit to the tipper, no bar to trading

a. Liability where (Dirks):i. Tipper breaches fiduciary duty by disclosing info to tippee, AND

ii. Tippee KNOWS there has been a breach & Trades , ANDiii. Tipper seeks to get direct/indirect personal/reputational benefit from tipping

info to tippee1. Tipper must EXPECT tippee to act on insider info provided- Benefit

must be the motivation- does not matter if Tippee actually benefittedb. Dirks v. SEC: D investigated corp for fraud & discovered info from a tipper

(employee). He told clients who then sold their shares.i. HELD for D: even though tipper had FD to company, he only disclosed info

to D to eliminate fraud. Dirks received NO personal benefit from disclosurec. Remote Tipper- Tracing Benefits (chain): Once the chain is tainted from the tipper

(b/c they expected a benefit or misappropriated) it is tainted down the line IF you prove each tippee knew origin of the info

i. Ex. Insider tells A for benefit. A tells B w/o receiving benefit. B tells C for no benefit, who trades and knows where info came from.

1. A is liable (Dirks); B is NOT liable (did not trade, didn’t give benefits to A before tipping & received so benefit); C is liable b/c he traded and knew where the info came from

5. Non-Insiders: Regulation Full Disclosure (FD): Adopted to address Dirks paradox. It is legal to give info to analysts if you prefer 1 innocently, but if you do it to get a break on commission or give you IPO stock, it is illegal. This levels the playing field between big analysts & smaller ones. Obligation of FD is on the issuer (not the broker)

a. If insider intentionally gives material info to certain people (institutional investor) must be SIMULTANEOUSLY disclosed to the public

b. If insider non-intentionally gives material info must be PROMPTLY disclosed to public (24 hours)

i. Ex. CFO has lunch w/analysts and accidently discloses SEC investigation: must promptly disclose via press release

6. Non-Insiders: OVERHEARING INFO: a. If you accidentally overheard you CAN trade

i. SEC v. Switzer: D overhears 2 tycoons talking about merger and traded on the info. HELD for D- not an insider (no FD) & no benefit to tipper & no misappropriation (no connection between tycoons & him)

b. If you intentionally overheard (put yourself in position) CANNOT tradei. Hypo: Electrician puts himself in position to go to offices where he is not

supposed to while working & traded on info. HELD for P: He is an independent contractor, so no FD but liable b/c he was snooping

e. DAMAGES: Can be sued by SEC & ANY private P who qualifies under 10b-5 (can recover difference in purchase price & market price after material info is known) except that:

i. §20(a) Private Suits for Insider Trading:

1. NO privity requirement : liable to everyone who bought/sold even if they did not know you2. Total amount of damages shall not exceed profits gained or lost avoided by insider; deduct

SEC finesii. §21(a): SEC can sue for civil penalties up to 3x profit made or loss avoided (paid to US treasury)

4. PRIVATE Rights of Action under ’34 Act: WHO YOU CAN SUEa. 3 Potential Defendants: eligible for suit as per SEC (look for Scienter)

i. Primary Violators : person w/scienter that lied or committed the fraud (“the bank robber”)- affirmative doer There IS a private right of action

ii. Secondary Violators : person who helped, was instrumental (would not have happened w/o them) to the crime & intended to assist (scienter)- (“the getaway car driver”)- affirmative doer there IS a private right of action

iii. Aider & Abettors : do NOT have scienter, basically bystander who got no benefit from it happening but w/o him it couldn’ have happened (“guy that held the door w/o knowing they were robbing the bank”) NOT liable in private action BUT SEC can sue (Central Bank of Denver)

b. Control People: can be J&S liable w/the other 3 groups for FAILURE to control the primary/secondary violators (via respondeat superior) based on private right of action

i. DEFENSE: not liable if control person acted in good faith & didn’t induce the acts constituting the violation

c. Example: A announces it intends to acquire B. The announcement includes audited and unaudited financial statements. B’s management had previously falsified its records (but A didn’t know). B’s management once again overstates the firm’s combined earnings in the announcement. A discovers it and discloses it. The price of shares then plummet, and shareholders sue B’s management and A’s management.

i. B’s management is obviously the primary violator here. A’s management however has the questionable liability – they are definitely aider and abettors, but may not be secondary. If you apply the substantial participation test they may be liable as secondary violators (and they’ve used unaudited financials, so that is perhaps substantial participation) – But under the bright line test, they haven’t actually done anything.

ii. If instead B’s management had been convicted of falsifying the records, then we [liability for A?] move up a notch – they surely pass muster under the substantial participation test, but they may even pass under the bright line test – now they’ve done something which is pretty much reckless disregard of the truth.

SEC ENFORCEMENT OF THE SECURITIES LAWS1. General: SEC can enforce against ALL 3 types of violators. ’33 & ’34 act are also criminal statutes but have several

steps for criminal indictment (only brought by Justice Dept)a. SEC Division of Enforcement: Investigatory powers but NO criminal authority SEC must show proof to

Justice Dept & they decide whether to bring criminal actionsi. If civil, SEC deals w/everything

ii. SEC must act on all complaints received, even if only informally2. SEC Investigations

a. INFORMAL Investigation : SEC just asks questions and everything is voluntary at this point, not required to submit any information – there is no subpoena power

i. First thing SEC does if gets a complaint is to call the issuer/lawyer and inquire about complaint topic you can voluntarily talk to them informally and send over info/proof.

ii. SEC does NOT have to disclose who the target of the investigation is – can just pursue info. b. FORMAL Investigation : If informal investigation raises suspicion, staff can petition the commissioners for

formal investigation.i. SEC now can subpoena, making info production mandatory (client can remain silent via 5th Amend.).

ii. SEC now advises issuer/person that they’re the target of a formal investigation.c. Wells Notice – indicates that the SEC has determined it may bring a civil action against a person/firm, and

gives them an opportunity to provide info (“Wells Submission”) for why action should not be brought.i. Regulators are not legally required to provide a Wells Notice; however, SEC often does.

d. Wells Submission : Last chance for Target to provide info to SEC to dissuade them from bringing enforcement action.

i. Everything disclosed in a Wells Submission may be used against the target if the SEC action proceeds.

e. UPON completion of formal investigation SEC enforcement division (staff) will make a recommendation of whether to bring an action or not (need 3/5 commissioners to approve).

i. MANY CASES settle at this point—SEC loves settlement; SEC can turn a breached settlement into an injunction w/criminal repercussions for if you breach.

3. Remediesa. CIVIL Enforcement – letter of reprimand, censure, fine, cease & desist order (stop what your doing),

injunction (don’t do it again), redo financial records up to SEC standards, etc.i. If violate injunction, then SEC will sue on injunction and Target can face criminal liability.

b. CRIMINAL Enforcement – ask for full sentences in law (but DOJ needs to bring the case)4. ETHICAL OBLIGATIONS OF A SECURITIES LAWYER

a. Securities lawyers owe a duty to both their client AND the investing public : no other type of lawyer has this double obligation

i. SEC v. National Student Marketing: Lawyer tells client before a merger was to finish, comfort letter (from accountants for SH saying they are comfortable w/the financials) was not ready. Client tells lawyer to close the deal anyway so he does. Later, the merger company failed & SEC sued everyone (including lawyers). Acquiring lawyer was not punished (said he followed his client)- Settled

1. This was a SECONDARY violator: knew that SH & investing public didn’t have material info prior to transactions

b. Case History:i. In re Carter & Johnson: client wouldn’t make proper disclosure even though attorney gave correct

legal advice. SEC claimed lawyer had ethical obligation to MAKE client follow the rules undecided

ii. In re George Kerns: issuer left all disclosure obligations & decisions to lawyer (who was also a director) but made the decisions as a lawyer and didn’t update when there was a material change in situation. Lawyer cannot make material decisions, only give advice

c. SOX § 307: Rules Relating to Attorney Conduct: SEC shall issue rules in the public interest & to protect investors, setting minimum standards of professional conduct for attorneys

i. Rule 205: LAWYER MUST REPORT UP & MAY REPORT OUT re securities violations1. Purpose & Scope: where the standards of a state or other US jurisdiction where an attorney is

admitted or practices conflict w/this part, this part shall governa. Applies to those practicing securities law

2. Representing an issuer : an attorney before the SEC in the representation of an issuer owes his professional & ethical duties to the issuer as an organization (NOT the specific individuals)

a. Attorney client privilege ONLY applies to client the corporation: if directors/officers tell you stuff it is not covered by privilege

3. DUTY TO REPORT UP (MANDATORY): 3(a)- duty to issuera. If attorney becomes aware of evidence of a material violation by the issuer, the

MUST report it to the issuers Chief Legal Officer OR both the issuers CLO & CEO fits w/in confidentiality

i. CLO MUST conduct inquiry into the evidence of a material violation AND determine if the material violation occurred, is ongoing, or is about to occur

1. If CLO determines NO material violation exists, they MUST notify the reporting attorney & write the basis for the determination

b. If reporting attorney reasonably believes the CLO has NOT provided an appropriate response, then they MUST report the evidence of a material violation to:

i. Audit committee of the issuer, ORii. Another independent committee of the issuer, OR

iii. Issuers board of Directorsc. If attorney reasonably believes it would be futile to report evidence of material

violation to the issuers CLO and CEO, they may report directly to the audit committee or BOD

4. Reporting OUT (OPTIONAL) Rule 3(d)(2)

a. Attorney MAY reveal to the SEC, w/o the issuers consent, confidential info related to the representation to the extent the attorney reasonably believes necessary to:

i. Prevent issuer from committing a material violation likely to cause substantial injury, OR

ii. Prevent issuer from perjury in SEC investigation or from perpetrating a fraud upon the SEC, OR

iii. Rectify the consequences (injury) of a material violation the issuer caused upon others

b. Summary: may report out & not violate attorney client privilege if you are unsatisfied w/the issuers response

ii. GOOD Faith Requirement: Rule 6(c): An attorney who complies in good faith w/these parts shall not be subject to discipline under inconsistent state standards

1. If not in good faith: Sanctions & Discipline: Civil penalties & remedies can be brought by SEC; may be denied right to practice before SEC

d. Professor G Speech: Mandatory Reporting Out? would probably make reporting OUT mandatory (NOT optional).

i. “I believe in broad consensus that lawyers should play a critical gatekeeping role in large public corporations. The term “gatekeeper” suggests a guardian w/independent professional responsibilities (aka: independent from the client), including a responsibility for protecting the institution (securities practice, SHs).”

ii. FAVORS reporting out b/c it is more important to protect investing public than to have confidentiality.

1. Current conflict b/w obligation to public & to client b/c latter should be able to tell lawyer anything and problem arises if you MAKE attorneys relay that info to SEC – compromises integrity of whole system.

2. Noisy withdrawal – stop being attorney b/c client does bad stuff and won’t listen, so make a noisy withdrawal to alert others (e.g.: publish in WSJ) to alert others.

e. SUMMARY of Ethical Obligationsi. Started w/NSM – owe obligation to client and investing public

ii. THEN SOX said rules for public interest and to protect investorsiii. THEN RULE 205 – reporting up is mandatory by lawyers (disclose violations to issuer to

remedy).iv. Reporting out – permissive, but Goldschmidt thinks it will become mandatory.